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THE    PRINCIPLES   OF 
BOND     INVESTMENT 


BY 
LAWRENCE   CHAMBERLAIN 

Of  Lawrence  Chamberlain  and  Company,  Inc.,  New  York 

115  Broadway 


SEVENTH   EDITION 


*  r 


NEW   YOKK 
HENRY  HOLT  AND  COMPANY 


Copyright,  1911, 

BY 

HENRY  HOLT  AND  COMPANY 


Published  November,  1911 


THE    QU1HN    *    BOOFN    CO.    PRESS 
RAHWAT.    N     J. 


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PREFACE 

There  is  so  much  miscellaneous  matter  in  this  book  that  the  reader 
who  is  seeking  some  specific  detail  is  advised  to  consult  freely  the 
Table  of  Contents,  and  above  all  the  Index.  The  Table  of  Con- 
tents is  arranged  to  show  at  a  glance  the  argument  of  the  work; 
the  line  of  thought  can  readily  be  traced  there,  and  it  will  serve  those 
who  wish  a  bird's-eye  view  of  the  field  of  bond  investment,  and 
those  who  wish  to  refresh  their  memories  as  to  the  subject-matter 
of  this  book.  The  Index  is  exceedingly  full  and  should  enable  one 
to  find  any  detail  he  seeks. 

It  has  seemed  impracticable  to  write  the  book,  throughout,  to 

2  scale.    Certain  topics  have  been  treated  briefly  because  they  form 
» the   subject-matter   of   books   that   are   already   in    print   or   that 

1  friends  now  have  in  preparation.    Part  II,  devoted  to  Civil  Loans 

<  (i.e.  government  and  municipal  loans),  is  the  most  detailed.    This 

:  is    because   so   little,    comparatively   speaking,    has   been   written 

hitherto  about  these  securities.    Railroad  finance  has  received,  and 

3  is  now  receiving,  careful  and  elaborate  study.  Municipal  finance 
>  has  been  strangely  neglected  and  the  practice  of  it  is  at  sixes  and 
K  sevens.  It  is  hoped  that  law-makers  and  municipal  officers  may  find 
^  suggestions  here,  from  illustrations  of  the  bond  practice  of  others, 
rj  by  which  they  may  standardize  and  improve  the  laws  of  this  coun- 
try pertaining  to  municipal  debt. 

^  There  is  another  sound  reason  for  elaborating  the  chapters  on  Civil 
1  Loans.  The  conditions  which  occasion  municipal  borrowing  are 
t  sufficiently  uniform  to  make  correct  generalization  possible.  No 
generalizations,  equally  broad,  are  safe  for  the  bonds  of  most  private 
corporations,  especially  of  railroads,  for  private  corporations  are 
so  sensitive  to  changes  in  industrial  conditions,  in  management, 
and  in  policies,  and  the  bonds  of  private  corporations  are  so  diverse 
in  nature,  especially  the  bonds  of  railroads,  that  principles  which 
will  apply  at  one  time  may  not  at  another. 

When,  however,  the  nature  of  the  business  is  such  that  basic 
industrial  conditions  bear  an  intimate  relation  to  investment 
principles,  as  in  the  gas  business,  one  can  form  a  clear  and  reason- 

iii 

265789 


iv  PREFACE 

ably  adequate  idea  of  what  to  choose  and  what  to  avoid  when 
buying  the  bonds.  But  for  the  securities  of  manufacturing  and 
industrial  companies  generally,  investment  principles  degenerate 
intu  a  series  of  caveats,  until  it  seems  as  if  the  only  dictum  of 
common  application  is  the  caution  caveat  emptor,  "  let  the  buyer 
beware." 

It  is  no  reflection  on  the  class  of  securities  called  Industrial 
Bonds  that  they  do  not  receive  treatment  in  these  pages.  The 
inference  is  merely  as  implied  above,  that  the  conditions  governing 
their  issuance  are  not  sufficiently  uniform  for  safe  generalization. 
It  is  felt  that  this  statement  still  applies  to  the  bonds  of  electric 
light  companies,  although  they  are  strictly  of  the  Public  Utility  type. 
Therefore  no  chapter  on  Electric  Light  Bonds  has  been  included. 
Telephone  companies  are  now  emerging  from  the  construction 
stage  of  development  into  the  investment  stage;  but  until  present 
corporate  relationships  are  altered  a  frank  discussion  of  Telephone 
Bonds  is  invidious  discrimination.  It  is  hoped  that  no  other 
omissions  are  of  sufficient  importance  to  require  explanation. 

Whatever  has  been  accomplished  in  this  book  is  due  in  large 
measure  to  the  unstinted  cooperation  of  many  people,  both  friends 
and  strangers.  But  no  one  except  the  writer,  and  no  firm,  is  re- 
sponsible for  any  expression  of  opinion  or  statement  which  is  open 
to  dispute.  Mr.  Walter  H.  Lyon  has  generously  fulfilled  the  offices 
of  long  friendship  by  reading  much  of  the  manuscript.  In  certain 
textual  matters  Mr.  Thomas  L.  Cole  has  lent  his  ripe  scholarship 
and  critical  taste.  In  matters  of  law  Mr.  Lyon  and  Mr.  Alfred 
D.  Chandler  have  given  invaluable  aid  by  criticisms  and  sugges- 
tions, and  by  the  loan  of  published  and  unpublished  material.  Mr. 
Montgomery  Rollins'  veteran  experience  in  bond  mathematics,  lit- 
erature, and  {tract  ice  and  his  kindly  interest  have  been  freely  drawn 
upon.  Mr.  Charles  A.  Hobbs  has  also  materially  improved  the 
chapters  on  mathematics,  particularly  the  work  in  logarithms.  In 
relation  to  prices,  the  help  of  Mr.  Wesley  Steele  and  the  Financial 
Graphic  Company  has  been  acknowledged  in  the  text. 

Mr.  F.  D.  Warner  has  contributed  to  the  chapter  on  Reclamation 
Issues  from  his  knowledge  as  an  engineer  and  financier  of  irriga- 
tion projects;  and  Mr.  Rufus  Coffin,  by  long  dealing  in  obsolete 
securities,  has  been  able  to  further  the  discussion  of  default  and 
repudiation  in  its  practical  aspects. 

Mr.  Floyd  Mundy  and  Mr.  John  Moody  have  gone  over  what  has 
been  said  about  the  railroads,  and  Mr.  Joseph  Talbot,  Vice  President 


PREFACE  v 

of  the  National  City  Bank,  has  been  of  assistance  in  the  prepara- 
tion of  the  comments  on  bond  prices  in  relation  to  credit,  etc. 

It  is  a  matter  of  regret  that  ethics  does  not  permit  mention  of 
those  banking  houses  which  have  been  called  on  to  judge  the  cor- 
rectness of  the  comments  on  the  types  of  bonds  in  which  they 
specialize. 

Acknowledgment  is  due  for  permission  to  print  the  substance  of 
a  few  of  the  writer's  past  and  forthcoming  contributions  to  Moody's 
Magazine,  the  Rollins  Magazine,  the  Banker's  Magazine,  Invest- 
ments, and  the  Journal  of  Accountancy. 

The  list  of  willing  helpers  might  be  indefinitely  prolonged  bj 
mention  of  aid  received  from  officials  at  Washington  and  in  many 
other  cities.  Perhaps  it  will  enliven  this  preface  to  say  that  in 
no  case  has  an  official  of  a  community  which  shows  a  tendency  to 
evade  its  just  engagements  made  reply  to  letters  of  inquiry. 

It  has  seemed  best  to  keep  the  book  as  free  as  possible  from 
footnotes;  therefore  a  detailed  acknowledgment  of  sources  has  not 
been  possible.  All  the  well-known  financial  periodicals  have  been 
drawn  on,  especially  the  Commercial  and  Financial  Chronicle,  with- 
out which  much  valuable  matter  would  have  remained  inaccessible. 

Errors  undoubtedly  will  be  found  in  this  book,  which  has  been 
produced  in  the  scant  leisure  and  amid  the  many  distractions  of  an 
active  business  life.  Criticisms  and  suggestions  will  be  welcomed 
by  the  author  and  will  be  of  value  to  him  in  a  future  revision  of 
the  text.  At  the  same  time  he  asks  lenient  judgment  upon  the 
faults  of  a  pioneer  work,  in  an  extended  field,  by  one  whose  daily 
occupation  is  to  buy  and  sell  rather  than  to  expound  investment 
securities. 

Lawrence  Chamberlain. 

Montclair,  N.  J.,  June  1,  1911. 


PREFACE  TO  THE  THIRD  EDITION 

The  changes  that  have  been  made  in  the  revised  text  are,  for 
the  most  part,  corrections  of  clerical  errors.  Many  references  are 
brought  up  to  date,  particularly  in  the  chapter  on  United  States 
Bonds.  From  several  quarters  the  author  has  been  urged  to  add 
extended  comments  on  types  of  bonds  not  treated  as  fully  as 
circumstances  warrant.  He  hopes  to  be  able  to  do  this  before 
another  printing. 


CONTENTS 

PART  I 
THE  CHANNELS  OF  INVESTMENT 


CHAPTER 


PAGE 


I.    Introductory 1 

II.    Gambling,  Speculation,  and  Investment 7 

Gambling— Speculation— Investment— Speculation  the  Art:  In- 
vestment the  Science. 

III.  The  Elements  of  an  Ideal  Investment 13 

Security  of  Principal— Stability  of  Income— Fair  Income  Re- 
turn— Marketability — Value  as  Collateral— Tax-Exemption — Ex- 
emption from  Care— Acceptable  Duration — Acceptable  Denom- 
ination— Potential  Appreciation. 

IV.  Stocks  Versus  Bonds 29 

Security  of  Principal— Stability  of  Income— Fair  Income  Re- 
turn —  Marketability  —  Hypothecary  Value — Tax-Exemption— 
Freedom  from  Care — Acceptable  Duration — Acceptable  Denom- 
ination— Appreciation. 

V.    The  Channels  of  Investment 38 

Investments  Classified  by  the  Nature  of  the  Interest— Invest- 
ments Classified  by  the  Contract  of  Redemption — Demand 
Loans— Optional  Loans— Perpetual  Loans — Time  Loans. 

VI.    Bonds  Versus  Mortgages 46 

Security  of  Principal— Security  as  Affected  by  Guaranty— Secur- 
ity of  Interest — Fair  Income  Return — Marketability — Hypothe- 
cary Value — Tax-Exemption — Freedom  from  Care — Acceptable 
Duration — Acceptable  Denomination — Potential  Appreciation — 
Conclusion. 

VII.    Listed  Versus  Unlisted  Bonds 62 

Security — Negotiability — Current  Versus  Uncurrent  Bonds — 
Hypothecary  Value— Net  Income — The  System  of  Bond  Houses 
as  an  Investment  Exchange — The  Unreliability  of  some  Listed 
Quotations— Conclusion. 

VIII.    The  Classification  and  Description  of  Bonds  :    According  to 

the  Character  of  the  Obligor 

The  Four  Schemes  of  Classification— Classification  According  to 
the  Character  of  the  Obligor. 

vii 


viii  CONTENTS 

OlIAI'TER  PAGE 

IX.    The  Classification  and  Description  of  Bonds  :     According  to 

Till.    Mi  I  BITS     FOB   THE   BONDS 72 

Simple  Obligations — Corporate  Debentures — Reinforced  Obliga- 
tions—Guaranty  Security — Lieu  Security — Lien  on  Personalty — 
Lien  on  Realty— Mortgage  Incidence — Mortgage  Priority. 

X.    The  Classification  and  Description  of  Bonds:    According  to 

the  Purpose  or  Function  of  the  Issue 100 

XI.    The  Classification  and  Description  of  Bonds  :    According  to 

Conditions  Attending  Payment  of  Interest  or  Principal  .  105 
Division  According  to  Payment  of  Interest — Division  According 
to  Payment  of  Principal — Division  According  to  Maturity  of 
Principal — Division  According  to  Maturity  as  Affected  by  tbe 
Payor's  Option — Division  According  to  Maturity  as  Affected  by 
tbe  Payee's  Option. 


PART  II 

CIVIL  LOANS 

XII.    United  States  Bonds 115 

Net  Yield — Causes  of  tbe  Low  Rate — History  of  tbe  National 
Debt — Tbe  United  States  a  Debt-Paying  Nation — National  Re- 
sources— A  Home  Market  for  National  Loans — National  Bank 
Demand — Price  Fluctuations;  Past  and  Future — Fluctuation  in 
Times  of  War — Fluctuation  in  Time  of  Panic — Effect  of  Bank- 
ing and  Currency  Measures  Upon  Prices — Desirability  of  United 
States  Bonds  for  Investment — Details  Concerning  United  States 
Bonds. 

XIII.  State  Bonds:    The  History  of  State  Debt       ....      122 

State  Bonds  in  tbe  Scbeme  of  Classification — State  Debt  and  Con- 
stitutional Law — Debts  of  tbe  Commonwealths:  Default  and  Re- 
pudiation— The  First  Repudiation  Period — War-Time  Repudia- 
tion and  Default — The  Second  Repudiation  Period — The  Ulti- 
mate Cause  of  Repudiation. 

XIV.  State  Bonds:    TnE  Elements  of  Security         ....      138 

Security:  Intangible  Assets:  The  Gauge  of  State  Credit — 
The  Lesson  from  History — The  Present  Attitude  of  the  States — 
Constitutional  Debt-Restrictions — Statutory  Debt-Restrictions 
and  Corollary  Acts— Significance  of  Recent  Legal  Decisions — 
Significance  of  Amount  and  Character  of  Present  Funded  Obli- 
gations. Security:  Tangible  Assets  :  The  Tax  Power — Tax- 
able Wealth  and  Assessed  Valuation — Equalized  Valuation — 
Relation  of  Assessed  Valuation  to  Real  Valuation — Comparison 
of  Valuations— The  Components  of  Assessed  Valuation — Other 


CONTENTS  ix 

CHAPTER  PAGB 

Items  of  Material  Wealth— Population — Bank  Statements — Off- 
sets of  Liabilities  Security  as  Vested  in  the  Bond  Issue  : 
Amortization:  Sinking  Fund  and  Serial  Repayment — Validity — 
Investment  Value:  Price  and  income  Held — Market  Factors — 
Bond  Characteristics— Conclusion. 

XV.    County  Bonds 159 

The  Municipal  Division  of  Tax-Secured  Bonds— Characteristics 
of  the  Municipal  Division— The  Economic  Function  of  the 
County — The  Range  of  Quality  in  County  Loans.  Material 
Assets:  The  County  Statement— The  Tax  Power  and  Its  Limi- 
tation— The  Tax  Rate — Assessed  Valuation — Other  Resources: 
Secondary  Income— County  Debt— The  Real  Debt  of  Municipal 
Counties— The  Real  Debt  of  Rural  Counties— Contingent  Debt ; 
Quasi  County  Bonds— Debt  Limitations.  Validity:  The  Par- 
tition and  Annexation  of  Counties.  Good  Faith  :  The  Extent 
and  Cause  of  County  Repudiation— The  Persistence  of  County 
Repudiation — Rural  Versus  Municipal  Counties — Metropolitan 
Counties— Other  County  Bond  Matters. 

XVI.    City  and  Town  Bonds:    Municipal  Assets         ....      180 

Municipal  Corporations  Proper  — Financial  Competency: 
Material  Assets:  The  City  Statement— The  Tax  Rate — The 
Tax  Power— Specific  Bond  Taxes— The  Tax  Limitation — As- 
sessed Valuation — The  Basis  of  Assessed  Valuation — Comparison 
of  Assessed  Valuations — The  Components  of  Assessed  Valuation — 
The  Relation  of  Realty  to  Personalty — Other  Resources;  Second- 
ary Income — Waterworks — Prior  Lien  and  Mortgage  Security — 
Population. 

XVII.    City  and  Town  Bonds:    Municipal  Liabilities  .        .        .      205 

Municipal  Debt— Contingent  Debt— The  Real  Debt  of  Cities  and 
Towns— Net  Debt— Sinking  Funds— Sinking  Funds  Versus 
Serial  Repayment— The  Redemption  Privilege— Debt  Limita- 
tions and  Restrictions — The  Referendum — Evasion  of  the  Debt 
Limit. 

XVIII.  City  and  Town  Bonds:  Validity  and  Good  Faith  .  .  .  225 
Validity — The  Causes  of  Illegality.  Remedies  of  Invalidity: 
Trust  Company  Supervision  and  Certification — State  Certifica- 
tion of  Validity — Validation  of  Issues  by  Courts  and  Legisla- 
tures— Estoppel  and  the  Bond  Recital — The  Bond  Attorney — 
Good  Faith.  Other  Matters  Affecting  Municipal  Credit: 
Price  Factors — Tax  Exemption. 

XIX.    The  Bonds  of  Tax  Districts 243 

Origin — The  District  Statement — The  District  Tax — Special 
Assessment  Bonds— Assessed  Valuation — Secondary  Resources — 
Mortgage  Security  —  District  Debt — Validity— Good  Faith- 
Rural  Versus  Urban  Districts — Metropolitan  Districts — Conclu- 
sion. 


CONTENTS 


PART  III 
CORPORATION  LOANS 

CHAPTER  PAOH 

XX.    Railroad  Bonds:    Proprietorship,  Management,  and  Plant  .      252 
Control,  Proprietorship,  and  Management:  Management. 
Physical  Characteristics:  Location— Mileage — The  Character 
of  the  Traffic — The  Character  and  Condition  of  the  Equipment — 
Statistics  of  Operation. 

XXI.  Railroad  Bonds  :  Earning  Power  and  the  Income  Account  .  263 
Operating  Revenues— Operating  Expenses— The  Maintenance 
Items — Maintenance  of  Way — Maintenance  of  Equipment — 
Traffic,  Transportation,  and  General  Expenses — The  Operating 
Ratio — Net  Operating  Revenue— Outside  Operations — Total  Net 
Revenue — Taxes  Accrued — Operating  Income — Other  Income — 
Gross  Corporate  Income — Deductions  from  Gross  Corporate  In- 
come; Fixed  Charges — Net  Corporate  Income — The  Margin  and 
Factor  of  Safety — Disposal  of  Net  Corporate  Income  or  Surplus. 

XXII.  Railroad  Bonds:  Valuation  and  the  Capital  Account  .  280 
The  Basis  of  Valuation — The  Balance  Sheet — Property  Invest- 
ment— Capitalization — Net  Capitalization — The  Relation  of  In- 
come to  Capital — The  Relation  of  Funded  Debt  to  Capitalization. 
Bond  Security  as  Affected  by  Priority  of  Claim:  The 
Relative  Positions  of  the  Various  Bond  Issues. 

XXIII.    Equipment  Trust  Obligations        .  292 

Origin— Car  Trust  Certificates— Car  Trust  Bonds— The  "Phila- 
delphia Plan" — Equipment  Bonds  or  Notes.  The  Present 
Legal  Status  of  Equipment  Obligations:  The  Modern  Trust 
Deed.  The  Financial  History  of  Equipment  Trust  Obli- 
gations: Depreciation  and  Serial  Payment — The  Margin  of 
Safety— Variations  in  Form — Investment  Return:  Popular  Pre- 
judice— Competitive  Demand— Growth  in  Favor. 

XXIV.    Steamship  Bonds 314 

Blanket  Mortgage  Steamship  Bonds — Equities — Insurance— Man- 
agement— "  Single  Boat  Bonds" — Steamship  Bonds  of  the  Great 
Lakes — Their  Record — Insurance — Earnings. 

XXV.    Street  Railway  Bonds 820 

The  Title— Variety  of  Kinds— History:  the  Urban  Road— The 
Interurbau — Interurbau  Centers — The  Western  Development: 
Competitive — The  Eastern  Development:  Saturative — Electrifica- 
tion of  Steam  Roads — Distinction  Between  Steam  and  Electric 
Securities — The  Investment  Principal:  Caveat  Emptor— Overcap- 
italization— Penny-Wise  Financing — The  Franchise:  Its  Life — 
The  Franchise:  Its  Character — Importance  of  Amortization — Im- 
portance of  Territory  Served — Investment  Characteristics. 


CONTENTS  xi 

CHAPTER  PAGE 

XXVI.    Gas  Company  Bonds 338 

Importance  of  the  Gas  Industry — The  Competition  of  Oil  and 
Electricity — Economic  Development— Fuel  Gas — The  Resid- 
uals— The  Elements  of  Successful  Operation — Importance  of 
Size  and  Population  Served — The  Relation  of  Rates  to  Popu- 
lation—The Relation  of  Output  to  Population — The  Decline 
in  Rates — The  Relation  of  Rates  to  Profits— Importance  of 
Modern  Management.  The  Bonds:  The  Bondholder's  Point 
of  View— Security— The  Effect  of  Hard  Times — Investment 
Suggestions — Market  and  Yield. 

XXVII.    Water  Company  Bonds 349 

Conditions  Affecting  the  Water  Supply — The  Question  of 
Quality — Conditions  Affecting  the  Water  Demand — The  Plant 
and  the  Business — Capitalization  and  Earnings — Management 
— Contracts  and  Franchises — Amortization — Water  Bonds  in 
Foreclosure. 

XXVIII.    Water-Power  Company  Bonds 357 

Water-Power  and  Steam-Power  Plants — The  Bonds:  Na- 
ture of  the  Security— Conditions  Affecting  the  Power- 
Supply — The  Drainage  Area— The  Storage  Reservoir— The 
Power-Plant  Construction — Conditions  Affecting  the  Power 
Demand— The  Power  Market— Competition— Nature  of  the 
Contracts— Responsibility  of  the  Lessees— The  Bonds:  In- 
come Yield— Other  Investment  Advantages — The  Operating 
Ratio— Appreciation— Marketability  and  Investment  Value. 

XXIX.    Real  Estate  Bonds 366 

The  Two  Kinds  of  Bonds— Real  Estate  Debentures- 
Security— Net  Yield— Negotiability— Duration  and  Appre- 
ciation—Record and  Future — Real  Estate  Mortgage  Bonds 
—Security— Net  Yield— Denomination — Negotiability— Du- 
ration— Leasehold  Mortgage  Bonds — Security — Eligibility 
for  National  Banks. 

XXX.    Timber  Bonds 375 

The  Lumber  Business — Tbe  Origin  of  Timber  Land  Bonds — 
The  Requirements  of  Mortgage  and  Deed  of  Trust — The 
Timber  Lands— The  Plant— The  Timber— Timber  Values— 
The  Fire  Hazard — Amortization — Management,  History,  and 
Earnings— Marketability  and  Income. 

XXXI.    Reclamation  Issues:    Irrigation  District  Bonds  .        .      384 

Irrigation  Bonds:  Early  Weaknesses— Land  and  Water 
Rights  and  the  Law— Federal  Irrigation — Tbe  National  Irri- 
gation Act — Present-Day  Irrigation  Under  State  Law.  Irri- 
gation District  Bonds. 


xii  CONTENTS 

CHAPTKR  PA«» 

XXXII.    Reclamation    Issues:     Private  Project    and   Caret    Act 

Bonds 392 

Private  Projects:  Factors  Making  for  Security — The  Water 
Supply— The  Water  Title  and  the  Water  Rights— The  Watered 

Land — The  Laud  Title — The  Scale  of  Private  Projects. 
Carey  Act  Projects:  The  Water  Supply — The  Water  Title 
and  the  Water  Rights— The  Watered  Land— The  Land  Title 
— The  Scale  of  Carey  Act  Projects — Summary — Disadvan- 
tages— Market  and  Net  Return — Future. 

XXXIII.    Reclamation  Issues:    Drainage  and  Levee  Bonds      .        .      401 
Scope    and    Character— Security— Net    Return — Duration — 
Market— Future. 


PART  IV 

THE  MATHEMATICS  AND  MOVEMENT  OF  BOND  PRICES 

XXXIV.    The  Mathematics  op  Bond  Values 405 

Net  Returns — Net  Dividend  Yield;  Perpetual  Securities — Net 
Interest  Yield:  Terminable  Securities— Premium — Discount 
— Nominal  Interest  Rate — Duration — Interest  Interval — The 
Interest  Rate  on  the  Sinking  Fund — Inaccuracies  in  the  De- 
termination of  the  Bond  Tables — The  Derivation  of  the  Bond 
Formulas— The  First  Formula— To  Find  the  Present  Worth 
of  $1  Principal— To  Find  the  Present  Worth  of  the  Interest 
Payments  or  Coupons — A  Second  Bond  Value  Formula — 
The  Application  of  the  Bond  Formulas — The  Application  of 
Bank  Discount  to  Bond  Transactions — The  Difference  Be- 
tween Discount  Price  and  Basis  Price  for  Bonds  Maturing 
Within  Six  Months,  and  the  Total  Ultimate  Gain— To  Dis- 
count a  Bond  Having  Two  or  More  Coupons  Attached:  i.e. 
Running  Over  Six  Months — The  Theoretical  Gain  by  Buying 
at  Discount  Rather  than  at  Basis,  on  a  Bond  Running  Over 
Six  Months,  but  not  Bought  on  an  Interest  Date. 

XXXV.    The  Use  of  the  Bond  Tables 426 

Accrued  Interest — Bond  Issues  of  One  Fixed  Duration — Un- 
tabulated  Figures:  Interpolation — Bond  Issues  cf  Serial  Du- 
ration— Bonds  of  Optional  Duration — Other  Bond  Tables. 

XXXVI.    The  Keeping  op  Investment  Accounts 444 

The  Basis  of  Investment  Value— Book  Value — Market  Value. 
Schedules  of  Amortization  and  Accumulation:  Sched- 
ules for  Bonds  Bought  on  Basis — Schedules  for  Bonds 
Bought  at  Price  and  Interest — Schedules  for  Bonds  Maturing 
at  Other  than  Regular  Interest  Dates — Schedules  for  Serial 
Bonds — Schedules  for  Redeemable  Bonds. 


CH  APT  Ell 

XXXVII. 


CONTENTS 

The  Fifty- Yeak  Course  of  Bond  Prices  .... 
A  Bearing  of  Speculation  Upon  Investment  Security— Security 
in  Liquidation— Statistical  Difficulties  of  Price  Study— The 
Subjects  of  Price  Study.  The  Development  of  National, 
Resources:  The  Charts  of  Population  and  Production — The 
Charts  of  Business  and  Per  Capita  Wealth — The  Charts  of 
Security  Prices. 


xm 

PAGE 

455 


XXXVTII.    Bond  Prices  in  Relation  to  the  Trade  Cycles  . 

The  15- Year  Charts— Approximate  Synchronism  of  the  Stock 
and  Bond  Price  Movements— The  Business  Cycle — The  Rela- 
tion of  Bond  Prices  to  the  Condition  of  Credit— The  Curve  of 
Bond  Prices  in  Elevation  and  Depression— The  Range  of 
Stock  and  Bond  Fluctuations— The  Present  Trend  of  Bond 
and  Stock  Prices. 


476 


XXXIX.    The  Future  of  Bond  Prices 491 

The  Prospect  of  Advance— The  Prospect  of  Decline— 
The  Increasing  Annual  Output  of  Gold— The  Quantity 
Theory  of  Money— The  Equation  of  Price— Gold  in  the  Price 
Equation— Velocity  of  Circulation— Commodities  in  the  Price 
Equation— The  Rapidity  of  Commodity  Exchange— The  Dis- 
tribution of  Money  and  Commodities— Local  Causes  for  the 
Increase  in  Commodity  Prices— Influences  Tending  Toward 
Lower  Prices— Influences  Tending  Toward  Gold  Absorption 
— Influences  Tending  Toward  Increase  in  Commodities— Con- 
clusion as  to  the  Future  of  Commodity  Prices— The  Relation 
of  Commodity  Prices  to  Bond  Prices. 


XL.    The  Bond  Houses 

The  Bond  Business— The  Functions  of  the  Bond  Houses— 
The  Purchasing  Function — The  Advisory  Function— The 
Banking   Function— The   Bond  Houses  as  Fiscal  Agents— 


The  Selling  Function- 


-The  Protective  Function. 


513 


Appendix. 


Index, 


The  Gamble  in  "Governments"  by  National  Bank*. 
W.  H.  Lyon 


By 


523 
533 


LIST   OF   CHARTS 

PAGH 

I.    The  Growth  op  Equity  in  Serial  Loans 309 

II.    The  Curves  of  Investment  Value 449 

III.  The  Population  op  the  United  States 460 

IV.  The  Production  op  Cotton  in  the  United  States    .        .        .  461 
V.    The   Production  op  Corn,  Wheat,  and   Oats  in  the  United 

States 462 

VI.    The  Production  op  Petroleum  in  the  United  States     .        .  463 

VII.    The  Production  op  Coal  in  the  United  States         .        .        .  464 

VIII.    The  Production  op  Iron  and  Steel  in  the  United  States    .  465 

IX.    The  Production  op  Copper  in  the  United  States    .        .        .  466 

X.    United  States  Imports  and  Exports  op  Merchandise      .        .  468 

XL    The  Bank  Clearings  op  New  York  and  of  the  United  States  469 

XII.    The  Per  Capita  Wealth  op  the  United  States       .        .        .  471 

XIII.  The  Prices  op  Listed  Railroad  Bonds  Since  1856     .        .        .473 

XIV.  The  Prices  op  Listed  Railroad  Stocks  Since  1856    .        .        .  474 
XV.    Comparative  Fluctuations  op  Bonds  and  Stocks,  by  Months, 

Since  1896 478 

XVI.  The  Symmetrically  Inverse  Variation  op  Railroad  Bond 
Prices  and  the  Ratios  op  Loans  to  Deposits— All  Na- 
tional Banks 483 

XVII.    The    Index    op    Fundamental    Conditions    in    the   United 

States 486 

XVIIL    The  Production  op  Gold  in  the  United  States  and  in  the 

World  Since  1857 493 

XLX.    Commodity  Prices  in  the  United  States  Since  1860         .        .  494 


PART  I 
THE    CHANNELS    OF    INVESTMENT 

CHAPTER  I 
INTRODUCTORY 

1.  Property,  as  the  possession  of  civilized  men,  is  fundamentally 
divided  into  two  kinds:  land,  with  whatever  is  permanently  at- 
tached to  it,  and  movable  goods  and  chattels.  The  relative  im- 
portance which  these  two  kinds  of  property  have  held  in  the  estima- 
tion of  men  has  varied  from  age  to  age  and  has  differed  among 
communities  according  to  the  degree  of  civilization  each  has  at- 
tained. 

As  man  cultivates  the  handicrafts  and  arts  and  develops  a  com- 
merce in  movable  possessions,  and  as  the  ultimate  dependence 
upon  the  soil  becomes  less  and  less  obvious,  the  second  form  of 
property  increases  in  relative  importance,  and  "  personalty,"  to  use 
the  more  modern  and  comprehensive  term,  ranks  with  "  realty." 

2.  Moreover  there  has  been  an  important  and  interesting  de- 
velopment of  personalty  itself.  Rights  and  franchises  and  other 
immaterial  forms  of  property  have  obtained  recognition  and  con- 
fidence as  stable  and  permanent  possessions  in  modern  systems  of 
law  and  order  built  upon  governmental  and  public  faith. 

With  man's  growth  of  faith  in  man,  and  with  the  necessity  for 
increased  facilities  of  exchange,  has  arisen  the  use  of  symbols  and 
certificates  of  possession  for  the  material  and  the  intangible  things 
possessed. 

3.  This  development  in  the  forms  of  personal  property  used  as 
media  of  exchange  is  historically  recorded  in  the  etymology  of  the 
English  language. 

Pecuniary  and  peculation  (Latin  pecus,  cattle)  carry  us  back  to 
the  agrarian  age,  when  beasts  of  the  field  were  the  medium  of  ex- 
change. Expense  (Latin  expendere,  to  weigh  out)  suggests  a  more 
settled  period  when  currency,  like  commodities,  was  measured  with 
scales,  rather  than  accepted  at  face  value,  or  denomination.  An- 
other advance  brings  us  to  money  (Latin  moneta,  a  mint)  which 
suggests  intrinsic  value  reinforced  by  civil  guaranty.    A  higher  form 


2  INTRODUCTORY 

of  commercial  development  is  reached  when  not  the  material  thing 
itself,  but  its  paper  certificate  of  ownership,  of  no  intrinsic  value, 
passes  without  question  from  hand  to  hand  as  an  accepted  symbol 
of  the  wealth  it  represents.  Security  in  this  stage  is  no  longer 
physical  possession  of  wealth,  but  the  faith  of  the  community  in 
its  system  of  political  and  commercial  credit.  A  typical  form  of  this 
representative  personal  property  is  the  bond  (cf.  Old  French  bonde, 
and  Middle  English  band,  a  bond,  a  tie). 

4.  The  bond  seems  to  violate  the  rule  of  historical  inheritance. 
Although  many  if  not  most  of  the  elements  of  modern  civilization 
are  traceable  to  Greek  and  Roman  antecedents,  or  at  least  to  origins 
antedating  the  Christian  era,  bonds  for  investment,  as  we  under- 
stand them,  do  not  seem  to  be  derived  from  antiquity.  In  fact  it  is 
not  until  the  latter  part  of  the  Twelfth  Century  that  we  meet  with 
them.  The  Venetians,  at  that  time  bankers  to  the  world,  used 
bonds  that  were  in  every  essential  analogous  to  our  civil  loans. 
They  were  direct  obligations  of  the  state,  interest-bearing,  redeem- 
able and  negotiable.  Venice's  system  of  certificated  loans  gradually 
spread  over  France  and  the  Low  Countries ;  and  from  the  Fifteenth 
Century  onward,  instruments  somewhat  analogous  to  our  corpora- 
tion and  real  estate  bonds  appeared  in  other  parts  of  Western 
Continental  Europe. 

5.  We  should  take  some  pride,  however,  in  the  fact  that  it  was 
reserved  for  us  of  the  New  World  to  develop,  to  the  full,  the  latent 
capabilities  of  the  sealed  instrument.  A  security  still  virtually 
unknown  to  English  common  law,  the  modern  negotiable  bond,  was 
conceived  in  the  peculiar  necessities  of  early  American  finance  and 
bravely  and  wisely  nurtured  by  the  federal  courts.  To  what  stature 
it  has  already  attained  will  be  seen  from  the  observations  of  the 
first  few  chapters  of  this  book.  Therein  an  effort  has  been  made 
to  seize  the  fundamental  principles  of  investment  and  to  show  how 
aptly  bonds  conform  to  them.  The  importance  of  bonds  as  a  chan- 
nel of  investment  is  also  illustrated  by  the  extension  of  juris- 
prudence within  the  past  half-century,  as  municipal  bond  law,  to 
cover  the  exigencies  arising  from  this  new  mode  of  financing. 

6.  If  bonds  play  such  an  important  part  in  latter-day  investment, 
and  particularly  in  American  investment,  it  ill  becomes  us  to  leave 
the  principles  of  bond  investment,  as  we  have  left  so  many  other 
financial  principles,  to  the  dissertations  of  French  economists.  The 
only  extended  attempt  we  know  of,  worth  mentioning  as  a  scholarly 
contribution  to  the  subject  of  bond  finance,  is  some  collected  arti- 


INTRODUCTORY  3 

cles  from  the  Journal  of  the  American  Academy  of  Political  and 
Social  Science.  But  the  merit  of  these  articles  is  very  unequal,  and 
they  are  not  ordinate  parts  of  a  general  system.  Indeed  the  more 
one  thinks  of  it  the  more  incredible  appears  the  supine  attitude  of 
American  bankers,  business  men,  and  teachers,  toward  the  cultiva- 
tion of  this  very  useful  and  honorable  field  of  thought. 

7.  From  a  strictly  academic  standpoint  the  development  of  bond 
investment  as  a  science  offers  exceptional  attractions.  Unexamined 
material  of  all  kinds  is  to  be  had  in  plenty.  The  method  of  necessity 
must  be  strictly  inductive,  for  the  projection  of  enterprise  by 
funded  debt  is  still  largely  experimental,  and  our  habits  of  thought 
upon  it  have  not  yet  become  formulated  and  regulated  by  authority, 
for  no  authority  exists.  It  is  true  there  is  little  danger  of  gross 
misinformation,  or  of  misinformation  at  all,  from  text-books,  for 
there  are  almost  no  texts.1  Moreover,  the  scientific  study  of  bond 
investment  implicates  a  sufficient  number  of  corollary  disciplines, 
such  as  banking,  statistics,  accounting,  civil  government,  and  law, 
to  allow  association  in  studies  with  courses  already  established  in 
every  university  curriculum. 

8.  A  stronger  appeal  than  that  to  our  American  universities,  al- 
ready overburdened  with  courses  of  utility,  may  be  made  to  those 
who,  next  to  the  investing  public,  have  most  at  stake,  the  American 
investment  bankers  themselves.  That,  as  a  class,  they  should  rest 
content  with  anything  short  of  the  highest  possible  technical  in- 
vestigation and  understanding  of  the  business  to  which  their  capital 
is  intrusted,  is  something  to  be  wondered  at.  But  the  fact  remains. 
And  it  is  not  universally  the  largest  houses,  doing  a  regular  inter- 
national business,  which  have  best  conserved  the  true  interests  of 
bond  investment  by  the  character  of  the  investigations,  or  the 
choice  of  securities  for  which  they  have  stood  sponsors. 

9.  If  anything  is  said  in  this  place,  seemingly  in  disparagement 
of  the  bond  fraternity,  of  which  the  author  is  a  member,  let  it  be 
read  in  the  light  of  the  closing  pages  on  The  Bond  Houses; 
but  we  should  either  give  up  the  idea  of  bond  dealing  as  a  profes- 
sion, or  else  contribute  to,  and  cordially  welcome  a  science  of  bond 
investment.  There  can  be  no  profession  without  a  science,  for  surely 
science  is  the  one  characteristic  which  distinguishes  a  profession 

1  There  are  no  texts,  unless  one  may  call  the  contributions  to  the  Journal  of 
the  Academy  a  text,  and  the  well-balanced  and  useful  introductory  book  en- 
titled Investment  Bonds,  by  Frederick  Lownhaupt,  New  York,  1908. 


4  INTRODUCTORY 

from  a  trade.    There  is  altogether  too  much  that  is  superficial  about 
bond  selling. 

10.  Bond  selling  is  too  largely  undertaken  in  a  haphazard  man- 
ner. It  is  true  that  there  are  good  salesmen  who  have  little  knowl- 
edge of  bonds;  but  it  is  also  true,  within  the  writer's  observation, 
that,  other  things  being  equal,  the  well-informed  and  trained  bond 
man  makes  a  more  effective  and  successful  salesman  than  one  who 
lacks  understanding  of  the  securities  he  offers.  The  responsibility 
for  the  lack  of  preparedness  rests  less  with  the  salesman  than  with 
the  bond  house  which  sends  him  out  without  furnishing  him  with 
means  to  a  proper  understanding  of  the  business  committed  to  him. 

11.  Salesmanship,  however,  is  only  one-half  of  the  battle.  What 
a  house  sells  it  first  must  buy.  There  is  a  saying  that  a  bond  well 
bought  is  already  half  sold.  As  an  economic  function  the  buying  of 
bonds  has  made  much  greater  progress  toward  perfection  than  the 
selling.  This  is  particularly  true  of  municipal  issues,  because  in 
each  case,  the  problems  that  confront  the  purchaser  are,  for  the 
most  part,  uniform  in  character.  The  chief  of  these  problems  are 
those  that  concern  legality  and  like  questions.  Every  large  house 
has  one  or  more  bond  attorneys  who  bring  professional  minds  to  the 
task  of  investigation  before  them.  In  purchasing  corporation  issues 
the  services  of  experts  in  the  field  of  the  corporation's  activities  are 
secured,  and  their  judgments,  to  a  degree,  are  the  basis  of  the  pur- 
chase. In  both  cases  the  influence  of  special  equipment  and  in- 
tellectual training  tends  to  permeate  all  the  other  elements  of  the 
functions.  A  reading  of  the  chapters  on  State  Bonds,  especially 
the  closing  paragraph  of  the  second  chapter,  should  convince  any 
one  of  the  necessity  of  even  more  scientific  bond  buying, — as  well 
as  of  scientific  bond  selling, — than  we  have  had  in  past  years. 

12.  But  of  all  interested,  the  investing  public  is  most  vitally 
concerned  in  the  elevation  of  bond  investment  to  an  applied  science ; 
for  the  public,  particularly  the  American  public,  is  the  ultimate 
repository  for  the  issues  of  our  corporations,  both  civil  and  private. 
In  the  past  the  burden  of  our  repudiations  and  defaults  has  fallen 
most  heavily  upon  Europe.  England,  the  Netherlands,  and  to  some 
extent  France,  have  suffered  more  than  we  by  the  follies  and  de- 
linquencies of  our  states,  municipalities,  and  railroad  and  banking 
companies.  It  is  Europe,  principally,  which  has  set  us  upon  our 
feet,  not  once,  but  repeatedly,  by  purchasing  our  credits  with  its 
surplusage.  But  henceforth  this  is  not  to  be.  At  anything  like 
the  present  rate  of  enlargement,  we  shall  soon  have  to  absorb  all  but 


INTRODUCTORY  5 

a  small  portion  of  our  own  municipal  and  corporate  indebtedness. 
Europe,  even  now  looking  to  other  continents,  can  be  counted  on 
to  take  only  a  tithe.  If  ever  again  over  a  thousand  million  dollars 
of  our  loans  come  due  and  remain  unpaid,  it  will  be  ourselves  we 
shall  have  cheated,  and  not  our  trustful  neighbors  of  the  Old 
World. 

13.  Therefore  we  must  institute  a  sound  and  thoroughgoing 
methodology  of  debt-creation,  bond  buying,  and  bond  selling.  In 
the  ultimate  analysis  the  development  of  a  bond  science  depends 
primarily  upon  the  statistical  department  of  the  banking  houses. 
Too  much  emphasis  cannot  be  placed  by  a  broker  upon  his  statis- 
tician, who  should  be  a  well-equipped  and  properly  compensated 
master-thinker,  and  not,  as  is  too  often  the  case,  an  underpaid  clerk. 
With  a  scientific  basis  in  the  statistician  the  buyer  would  be  less 
the  victim  of  the  unforeseen  and  unexpected  and  the  salesman  would 
not  go  on  the  road  trained  in  address,  primed  with  the  latest 
gossip  of  railroad  melon-cutting,  and  the  talking  points  of  his  lead- 
ing bonds,  really  sincere  and  frank  in  interpreting  the  information  on 
his  circulars,  but  for  the  most  part  utterly  unable  to  explain  or  com- 
prehend the  essential  investment  qualities  in  the  bonds  he  offers, — 
unable  to  tell,  for  instance,  whether  there  is  a  difference  between  a 
bond  and  note,  or  between  a  Car  Trust  Certificate  and  an  Equip- 
ment Bond.  Think  of  a  medical  man  who  could  not  distinguish 
the  scapula  from  the  clavicle!  Salesmanship,  so  represented,  is 
not  a  profession  but  a  trade.  The  dignity  of  it  is  barely  saved 
by  the  high  average  of  general  intelligence  among  bond  salesmen, 
and  by  the  high  plane  of  their  business  ethics. 

14.  What  may  be  said  of  the  bond  investor?  In  absolute  igno- 
rance of  the  very  titles  of  some  classes  of  bonds,  unfamiliar  with 
bond  law,  bond  history,  and  bond  practice,  unable  generally  to 
analyze  a  corporation's  financial  statement,  and  almost  never  the 
statement  of  a  municipality,  he  is  too  often  at  the  mercy  and  dis- 
cretion of  salesmen  who  are,  perhaps,  only  slightly  more  conversant 
with  bonds  than  he.  In  many  instances,  considering  the  usual 
difference  in  age,  business  experience,  and  practical  wisdom,  the 
salesman  is  less  prepared  than  the  client  to  guide  investment  money 
into  proper  channels.  Thus  a  statement  of  the  principles  of  bond 
investment  within  the  limits  of  one  volume,  ought  to  be  of  great 
service  to  bond  buyers. 

15.  A  most  important  service  that  can  be  rendered  to  all  by  an 
attempt  to  define  and  codify  the  principles  of  investment  is  to  make 


G  INTRODUCTORY 

general  the  knowledge  of  what  tends  toward  conservatism  in  finance. 
There  never  was  a  civilized  country  which  needed  such  a  service 
more  than  ours  forty  years  ago.  It  is  douhtful  whether  there  are 
many  which  need  it  as  much  as  we  to-daj'.  We  are  piling  up  our 
municipal  debts  at  an  extravagant  rate.  And  the  seriousness  of 
the  situation  is  that  the  East  is  the  worst  transgressor.  New  York, 
the  banking  center  of  the  western  world,  has  increased  its  popula- 
tion in  the  past  ten  years  39  per  cent.  Allowing  for  the  1903 
change  of  basis,  it  has  increased  its  assessed  valuation  about  32  per 
cent.  But  it  has  increased  its  budgetary  appropriations  for  munici- 
pal purposes  (as  distinguished  from  county  and  state  purposes) 
over  100  per  cent.,  and  its  "  net  funded  indebtedness  "  by  about  178 
per  cent.,  and  its  interest  charges  over  115  per  cent.,  or  from  12 
per  cent,  of  the  total  budget  to  about  17  per  cent.  Men  have  dis- 
agreed by  millions  as  to  New  York  City's  actual  debt. 

16.  Making  due  allowances  for  the  self-supporting  nature  of  many 
of  the  recent  loans,1  the  same  spirit  that  brought  about  this  state  of 
affairs,  bankrupted  the  West  and  South  seventy  years  ago,  and  again 
thirty-five  years  ago.  Yet  there  is  no  organized  opposition  from 
New  York  bankers  to  a  continuance  of*  this  debt-creating  policy. 
In  Massachusetts,  of  all  states  by  far  the  most  heavily  in  debt, 
earnest  and  public-spirited  citizens  who  have  made  a  profound 
study  of  local  municipal  debts,  are  receiving,  not  encouragment 
nor  indifference,  but  actual  opposition,  sometimes  even  from  bankers, 
in  their  endeavors  to  better  the  fiscal  conditions  now  prevailing. 
The  time  has  come,  says  Mr.  A.  D.  Chandler,  in  The  Brookline 
Chronicle,  to  insist  on  throwing  aside  any  veil  that  covers  the 
full  amount  of  a  municipality's  debt.  Any  one  familiar  with  the 
facts  who  does  not  do  so,  exposes  a  town  to  a  wrong  and  an  injury. 
"  The  present  Finance  Commission  in  Boston  has  recognized  the 
necessity  of  refusing  to  be  befogged  by  any  such  veil.  Brookline's 
debt,  instead  of  being  only  about  |1,381,330,  as  given  officially  in 
obedience  to  an  archaic  habit,  is  really  about  $4,891,908,  according 
to  the  computations  furnished  by  the  Town  Accountant." 

These  illustrations  of  what  remains  to  be  done  in  the  most  con- 
servative investment  field,  the  municipal,  suffice  to  show  the  need 
of  an  "  exact  science  "  of  bond  finance  and  bond  investment,  and  sug- 
gest the  relief  which  would  come  to  overburdened  communities 
should  the  principles  of  such  a  science  be  common  knowledge  among 
them. 

1 1909. 


CHAPTER  II 
GAMBLING,  SPECULATION,  AND  INVESTMENT 

17.  "  Writing  a  book,"  says  somebody,  "  is  very  much  like  flying 
a  kite :  it  is  pretty  plain  sailing  after  you  once  get  it  off  the  ground 
and  started."  We  have  to  do,  in  this  work,  with  the  principles 
governing  bond  investment  in  America.  Granted  the  premises  and 
all  things  follow  in  due  course;  but  first  it  is  necessary  to  secure 
acquiescence  in  the  premises,  i.e.  as  to  the  nature  of  investment; 
how  investment  is  to  be  distinguished  from  speculation;  and  the 
position  in  the  scheme  which  is  occupied  by  bonds.  From  that  we 
deal  more  generally  with  concrete  and  demonstrable  facts,  and 
the  chances  for  differences  of  opinion  are  fewer. 

18.  Many  would  divide  the  efforts  by  which  money  is  made  to 
earn  other  money  into  three  kinds:  gambling,  speculation,  and 
investment.  It  would  be  well,  if  possible,  to  come  to  some  general 
agreement  as  to  the  division  lines,  for  then  much  blind  legislation 
and  several  economic  fallacies  would  be  done  away. 

19.  Gambling.  Simon-pure  gambling,  we  take  it,  is  indulged  in 
when  one  risks  money  or  any  other  form  of  wealth  on  any  event  over 
which  he  has  absolutely  no  control  nor  foreknowledge.  Matching 
coins  or  shaking  dice,  fairly,  is  pure  gambling.  But  frequenters  of 
poolrooms  and  gambling  halls  will  aver  that  so-and-so  is  almost 
invariably  lucky  in  his  plays  of  the  sort.  Study  of  the  few  men  of 
this  repute  we  have  known  leads  us  to  the  conclusion  that  their 
winnings  are  due  to  the  observance  of  certain  mathematical  laws 
(e.g.  the  law  of  probabilities)  and  to  their  superior  insight  into 
human  nature.  Consciously  or  unconsciously  they  will  stop  their 
losses  and  let  their  profits  run;  or  they  will  double  their  stakes 
after  each  loss  until  a  winning  stroke  recoups  them,  and  then  they 
will  find  cause  to  withdraw  from  the  play  or  else  return  to  the 
original  smaller  stake. 

He  is  a  rash  man,  however,  who  limits  his  definition  of  gambling 
to  operations  dependent  on  pure  chance  for  their  success.  Betting 
on  races  and  games  is  gambling,  even  when  conditions  are  carefully 
studied, — unless  we  revise  the  dictionaries  and  the  language.    One 

1 


8  GAMBLING,  SPECULATION,  AND  INVESTMENT 

may  use  intelligence  as  it  is  ordinarily  and  properly  understood; 
and,  if  the  intelligence  is  of  sufficiently  high  order  of  its  kind  a 
living  may  be  got  from  it  which,  for  all  we  know,  may  not  be  so  pre- 
carious as  some  people  suppose. 

20.  Speculation.  Now  to  speculate,  say  the  dictionaries,  is  "  to 
make  a  purchase  that  involves  a  risk  of  loss,  but  also  offers  a  chance 
of  considerable  profit :  to  make  an  outlay  in  the  hope  of  probable 
gain."  It  is  hard  to  see  in  what  respect  this  definition  would  not 
do  equally  well  for  gambling  as  it  is  ordinarily  conducted,  except, 
maybe,  for  the  word  "  probable."  Strictly  according  to  the  defini- 
tion, at  the  race-track  one  purchases  of  a  bookmaker  the  right  to 
demand  a  certain  sum  of  the  bookmaker  providing  one's  opinion  is 
verified  that  a  certain  horse  has  at  the  time  of  the  race  greater  speed 
for  the  given  distance,  in  the  hands  of  the  given  jockey  or  driver, 
than  any  other  horses  entered  in  that  race  under  their  jockies  or 
drivers,  as  the  case  may  be. 

The  dictionary  definition  of  speculation  does  not  define,  to  the  ex- 
clusion of  gambling;  but  it  is  not  sufficiently  inclusive  if  it  did.  A 
novelist  contracts  with  a  periodical  to  supply  it  with  a  certain  num- 
ber of  stories  during  the  ensuing  year ;  and  a  forfeit  is  stipulated  if 
the  writer  defaults.  These  stories,  we  will  suppose,  have  not  yet  been 
written.  The  novelist  is  selling  something  he  does  not  possess  but 
hopes  to  make.  In  the  phrase  of  the  market  place  he  is  selling 
"  short,"  an  operation  peculiar  to  speculative  dealings,  but  not  in- 
cluded in  the  definition  above.  Both  parties  to  the  contract  are 
"  dealing  in  futures,"  a  form  of  transaction  native  in  its  accepted 
sense  to  gambling  and  speculation.,  but  foreign  to  investment.  It  is 
conceivable  that  if  by  reason  of  illness  or  prior  engagements  the 
novelist  took  great  chances  of  not  being  able  to  fulfil  this  contract, 
he  might  justly  be  accused  of  gambling. 

21.  The  distinction,  therefore,  between  gambling  and  speculation 
is  ethical  rather  than  economic.  Both  gambling  and  speculation 
are  dealing  in  futures;  and  the  difference  between  them  is  the  differ- 
ence in  motive,  and  in  the  degree  and  character  of  the  risk  involved 
in  pursuit  of  the  gain. 

There  are  innumerable  ways  of  saying  the  same  thing:  gambling 
is  undertaken  in  the  spirit  of  sport;  speculation  in  the  spirit  of 
business.  In  gambling  the  attraction  of  the  uncertainty  is  the 
leading  motive ;  in  speculation,  the  desire  for  gain. 

22.  By  the  usage  of  our  English  speech  there  is  a  form  of  busi- 
ness activity  commonly  called  speculation,  which,  according  to  thr 


GAMBLING,  SPECULATION,  AND  INVESTMENT  9 

distinction  drawn  above,  should  be  called  gambling:  namely,  the 
purchase  and  sale  of  stocks,  and  certificates  representing  commodi- 
ties, on  a  very  narrow  margin  of  equity,  and  without  intelligent 
opinion  as  to  future  values.  Since  gambling  of  this  sort  has  a  kind 
of  usefulness  in  "creating  a  market,"  and  assuming  (even  though 
unconsciously)  the  risk  that  would  otherwise  be  borne  by  producer 
and  consumer,  it  is  called  speculation,  honoris  causa,  for  its 
economic  service.  The  assumption  of  risk  with  benefit  to  the 
community  is  a  speculative  function. 

23.  Investment.  Just  as  the  gradation  from  gambling  to  specula- 
tion is  imperceptible,  and  there  is  no  hard  and  fast  line  of  demarka- 
tion,  so  speculation,  as  it  avoids  chance  to  a  greater  degree,  in 
pursuit  of  more  certain,  if  possibly  more  modest  opportunities  for 
gain,  graduates  imperceptibly  into  investment.  Likewise  if  it  is 
a  fair  contention  that  gambling  is  a  lower  order  of  activity  than 
speculation,  since  it  seeks  to  acquire  something  which  has  not  been 
earned,  and  in  the  operation  produces  no  new  wealth,  and  does  not 
more  favorably  distribute  wealth  which  exists,  then  investment  is 
a  higher  order  of  business  activity  than  speculation;  for  chance 
is  eliminated  as  nearly  as  possible,  and  all  operations  are  con- 
ducted in  compliance  with  natural  laws,  and  there  is  a  nicer  re- 
lation between  the  labor  and  the  reward,  and  there  is  less  loss 
or  waste  if  indeed  there  may  be  less  gain.  Furthei  aore,  investment 
more  surely  and  permanently  creates  new  wealth. 

24.  Apropos,  now,  of  the  relative  return  from  speculation  and 
investment,  what  proof  is  there  that  the  common  opinion  is  cor- 
rect, that  the  current  rewards  from  speculation  are  greater  than 
from  investment?  Are  dividend  returns  greater  than  interest  re- 
turns? Dividend  returns  are  not  the  only  profits  from  speculation, 
and  par  value  is  not  market  value.  But  this  much  we  know :  that 
railway  bond  interest  in  this  country  is  between  two  and  a  half 
and  three  times  railway  stock  dividends,  and  yet  the  funded  debt 
is  only  slightly  in  excess  of  share  capitalization.  General  business 
is  now  the  commonest  form  of  speculation.  Proprietors  expect 
and  receive,  to  be  sure,  when  successful,  higher  returns  than  lenders 
of  money  receive.  But  what  proportion  of  business  enterprises  is 
successful?  The  commercial  agencies  tell  us  that  more  than  one 
per  cent.,  on  the  average,  of  all  business  concerns  in  the  United 
States  fail  every  year.  A  financial  writer  and  editor,  whose  opinions 
carry  as  much  weight  in  Wall  Street  as  those  of  any  other  student 
of  finance,  was  recently  asked  by  a  friend  of  the  author  whether  he 


10         GAMBLING,  SPECULATION,  AND  INVESTMENT 

thought  in  the  long  run  speculation  or  investment  yielded  the  greater 
returns.    His  reply,  in  part,  was: 

"  I  know  of  no  data  on  the  question  of  the  comparative  results  of  invest- 
ment and  speculation.  The  results  would  differ  so  much  with  different  indi- 
viduals that  it  would  seem  impossible  to  gather  any  statistics  on  the  subject. 

"  My  own  belief  is  that  there  can  be  no  doubt  whatever  that  larger  gains 
are  to  be  made  by  investments  than  by  speculation  so  far  as  the  non-professional 
is  concerned." 

The  story  of  the  hare  and  the  tortoise  is  not  without  point. 
Investment  mills  grind  slowly,  but  they  grind  exceeding  sure. 

25.  Leaving  now  any  but  business  considerations, — when  a  man 
has  acquired  any  means  above  his  wants,  unless  he  wrap  the  sur- 
plus up  and  bury  it  in  a  napkin,  he  is  at  the  necessity  of  making 
a  choice  between  the  speculation  and  the  investment  of  it.  Two 
sets  of  influences  will  bear  upon  this  choice:  his  temperament  and 
his  environment.  The  acquisitive  man  will  have  in  mind  the 
small  but  certain  rental  which  his  money  can  always  command. 
He  is  the  investor  par  excellence,  and  his  savings,  literally,  control 
the  destinies  of  nations.  The  daring  and  less  patient  man  will 
seek  a  speculation  with  its  superior  opportunities  for  the  employ- 
ment of  his  creative  powers,  and  for  consequent  greater  possibility 
of  gain. 

The  play  of  circumstances  is  equally  effective,  and  will  turn 
almost  all  men  from  the  one  to  the  other  of  the  two  modes  of 
money-getting.  If  we  remember  that  this  act  of  choosing  is  gen- 
erally an  unconscious  matter,  and  is  going  on  all  the  time  for  all 
who  labor  and  save,  we  have  the  best  possible  viewpoint  for  con- 
templating the  eternal  round  of  choices  which  goes  to  the  making 
of  business  cycles.  That  is  to  say,  not  only  may  men  be  classified 
as  individually  and  natively  either  speculators  or  investors,  but 
collectively  they  are  first  the  one,  then  the  other.  When,  for  a 
period,  crops  and  gold  have  been  abundant,  and  prices  for  ma- 
terials and  labor  have  risen,  and  credit  may  be  had  almost  for  the 
asking,  the  spirit  of  speculation  becomes  general  and  well-nigh 
irresistible.  The  storekeeper  lays  in  a  double  stock,  the  clerk  bu}7s 
twopenny  mining  shares,  and  the  banker  loans  too  freely  on  col- 
lateral. Then  when,  according  to  the  old  figure,  "  the  bubble 
bursts  "  and  optimism  gives  way  to  fear,  there  comes  the  reaction : 
for  a  time  people  will  only  hoard;  but  when  they  make  commit- 
ments again,  the  choices  are  largely  for  investment. 


GAMBLING,  SPECULATION,  AND  INVESTMENT         11 

26.  Fortunate,  then,  are  the  very  few  who  are  qualified  to  be 
both  investors  and  speculators  of  their  surplus  funds.  These  men 
will  liquidate  their  commitments  at  the  flood  tide  and  invest  in 
loans,  subject  to  their  call,  which  at  such  times  are  almost  as  profit- 
able as  the  better  liquid  speculative  assets,  such  as  dividend-paying 
stocks.  Then  when  the  collapse  comes  they  are  prepared  to  ren:'  v 
their  investments  in  short  or  long  time  loans  until  conditions  war- 
rant the  withdrawal  of  these  funds  for  the  assumption  of  speculative 
risks  again. 

27.  Speculation  the  Art :  Investment  the  Science.  There  is  nothing 
invidious  in  a  comparison  of  investment  and  speculation.  Each  is 
necessary  to  the  other,  and  both  to  the  conduct  of  business.  There 
is  more  or  less  speculation  in  every  investment,  and  investment  in 
every  speculation.  But  in  the  large,  investment  is  a  science,  and 
speculation  is  an  art.  In  a  sense,  therefore,  it  is  inappropriate 
to  speak  of  "  the  art  of  investment,"  or  "  the  science  of  speculation." 
To  the  extent  that  investment  is  a  science  it  is  reducible  to  defini- 
tion, code,  and  law,  and  books  may  with  profit  be  written  about  it; 
but  in  so  far  as  speculation  is  an  art  and  distinguishable  from  in- 
vestment, it  must  remain  a  mystery  to  those  who  do  not  feel  its 
spirit,  or  else  be  learned  in  the  occult  ways  that  any  art  is  learned. 
Successful  speculation  cannot  be  learned  from  books.  It  is  in 
accord  with  our  thesis  of  speculation  as  an  art  and  of  investment 
as  a  science  that  successful  speculation  is  a  high  order  of  finance, 
but  unsuccessful  speculation  is  gambling.  This  riddle  is  not  hard 
to  solve. 

28.  As  art  precedes  science  in  the  development  of  a  race,  so 
speculation  precedes  investment.  Nothing  venture,  nothing  have, — 
to  invest.  The  Pharaohs  dealt  in  grain  futures,  and  perhaps  Joseph 
explained  to  the  King  a  phase  of  the  cycle  theory  of  speculation 
when  he  interpreted  the  dream  of  the  seven  well-favored  kine  con- 
sumed by  the  seven  ill-favored.  It  was  well  for  Egypt  that  for 
the  next  seven  years  Pharaoh  was  bullish  on  all  foodstuffs  and 
bought  20  per  cent,  of  the  country's  supply.  It  never  matters  what 
are  the  commodities  dealt  in,  speculation  takes  the  burden  of  risk 
from  the  shoulders  of  both  producer  and  consumer  of  any  kind  of 
product,  and,  when  successful  in  carrying  the  load,  receives  reward 
commensurate  with  the  service  rendered;  for,  to  repeat,  by  what- 
ever name  speculation  may  be  called,  it  always  has  had,  and  always 
will  have,  an  indispensable  function  to  perform  in  the  world's 
economy. 


12         GAMBLING,  SPECULATION,  AND  INVESTMENT 

29.  Since  the  assumption  of  risk  is  a  necessary  and  highly  bene- 
ficial service  when  performed  by  those  qualified  to  undertake  it,  the 
distinction  between  speculation  and  investment  is  not  primarily 
ethical.  Speculation  and  investment  are  actuated  hi/  the  same 
motive:  desire  for  <juin.  and  the  difference  between  them  is  the  differ- 
ence in  degree  of  risk  willing  to  be  assumed.  This  risk  finds  its  most 
patent  expression  in  the  ratio  of  current  return  expected  of  the 
capital. 


CHAPTER  III 
THE  ELEMENTS  OF  AN  IDEAL  INVESTMENT 

30.  _  Security  of  Principal.  It  follows  from  the  distinctions  drawn 
in  the  preceding  chapter  that  the  chief  requisite  of  a  perfect  invest- 
ment is  a  maximum  of  security  for  the  invested  principal.  If  it  is 
certain,  humanly  speaking,  that  the  principal  will  be  returned  when 
demanded,  or  at  a  time  agreed  upon,  or  that  it  can  be  converted  at 
will,  or  at  a  fixed  time,  into  some  equivalent  form  of  wealth,  equal 
in  value  and  equally  satisfactory  to  the  lender,  then  the  principal 

is  secure. 

31.  Now  there  is  one,  and  only  one,  word  in  the  language  to 
designate  the  employment  of  funds  in  accord  with  these  require- 
ments. It  is  the  word  loan.1  Contracts  which  are  essentially  pur- 
chases do  not  ordinarily  assure  to  the  buyer  revenue  from,  or  the 
return  of  his  expenditure.  No  unguaranteed  stock,  for  instance, 
however  good,  can  assure  a  future  realization  equal,  at  a  set  time, 
to  the  purchase  price.2  This  is  reasoning  by  the  book,  to  be  sure, — 
arguing  in  a  vacuum, — but  it  is  only  by  analyzing  investment  into 
its  primary  elements  that  we  can  attain  a  sound  and  enduring 
investment  practice. 

32.  The  moment  we  are  confronted  with  the  word  loan  we  realize 
how  few,  in  truth,  are  the  classes  of  investment  that  fulfil  require1 
ments.  The  purchase  of  real  estate  is  not  investment  in  the  strict 
sense.  The  purchase  of  bonds,  on  the  other  hand,  is  investment,  for 
the  purchase  is  in  reality  a  loan  and  must  be  paid.  The  purchase 
of  British  consols,  of  irredeemable  state  "  loans,"  and  of  the  per- 
petual "  loans "  of  continental  governments,  or  of  the  ordinary 
town  warrants,  sometimes,  is  not  a  loan,  and  therefore  not  an  in- 
vestment in  this  sense,  since  there  can  be  no  loan  where  there  is  not 

1  In  the  strictest  sense,  then,  investment  implies  divesting  one's  self  of  the 
possession  and  control  of  one's  assets  and  granting  such  possession  and  control 
to  another"    (Sprague:   The  Accountancy  of  Investment,"  p.  13). 

2  "  The  essence  of  strict  investment  is  vicarious  earning,  a  share  of  the  gain 
not  dependent  on  the  fortunes  of  the  handler"  (Ibid.). 

13 


14  THE  ELEMENTS  OF  AN  IDEAL  INVESTMENT 

a  promise  to  pay  the  principal,  and  there  is  no  true  promise  to  pay, 
when  there  is  no  payment  time  appointed.  On  the  other  hand,  de- 
posits in  national,  stale,  private,  and  savings  banks,  and  in  trust 
companies,  are  pure  investments,  when  interest  is  allowed,  since 
they  are  loans  for  a  consideration, — loans  which  there  is  a  written 
or  implied  promise  to  pay  on  demand  or  at  a  fixed  time,  and  also 
certain  forms  of  insurance  policies  which  contract  to  return  the 
principal  cost,  after  a  certain  time  and  under  certain  conditions. 
The  consideration  for  the  loan  in  these  latter  cases  may  be  taken 
to  be,  not  only  in  interest  accruing,  or  annual  participation  interest, 
but  possibly  even  the  fact  of  insurance  itself. 

It  is  not  necessary  to  state  that  many  instances  of  expenditure 
that  theoretically  come  under  the  head  of  speculation  are  safer  than 
some  instances  of  investment;  but  nevertheless  the  fact  remains 
that  every  class  of  pure  investment,  such  as  bonds  and  mortgages 
and  bank  deposits,  is  safer  than  any  class  of  speculation,  such  as 
stocks,  real  estate,  and  commodities. 

In  fine,  therefore,  the  perfect  investment  is  a  promise  to  pay;  it 
is  always  a  loan. 

33.  There  are,  however,  investments  that  meet  all  the  demands 
mentioned  and  yet  fall  short  of  being  ideal  for  certain  purposes. 
Some  issues  of  bonds  run  well  into  the  twenty-first  century.  From 
the  standpoint  of  present  generations  they  are  hardly  more  available 
in  theory  than  perpetual  loans.  As  loans  their  liquidation  value 
(security  apart)  is  dependent  upon  current  rates  for  mone3r,  rather 
than  upon  the  fact  that  at  some  future  time  100  per  cent,  of  their 
face  value  must  be  repaid  for  them.  The  shorter  the  life  of  the 
loan  the  more  surely  does  the  face  value  govern  the  current  value. 
This  is  why  national  banks,  which  must  at  all  times  be  prepared 
to  liquidate  a  large  part  of  their  investments,  choose  commercial 
paper  and  short  term  notes  and  bonds. 

But  on  the  other  hand,  for  convenience  in  complying  with  the 
laws,  or  for  economic  reasons,  interminable,  or  very  long  loans 
have  their  place  in  finance,  or  else  the  school  funds  of  some  of  the 
Western  states  would  not  be  invested  in  them.  Then  too,  testa- 
mentary trusts  which  the  founders  intended  to  continue  as  long 
as  our  laws  of  inheritance  and  entail  will  permit,  are  best  fulfilled, 
ordinarily,  when  left  in  the  form  of  investments  that  will  not 
mature  at  an  early  date.  In  such  investments  a  fixed  and  regular 
income  is  most  desired.  The  principal  will  perhaps  go  to  bene- 
ficiaries yet  unborn,  for  whom  there  is  less  solicitude. 


THE  ELEMENTS  OF  AN  IDEAL  INVESTMENT  15 

34.  Stability  of  Income.  An  investment,  therefore,  to  be  ideal, 
must  secure  to  the  lender  of  capital  a  fixed  rental  or  income  for  the 
use  of  it.  This  sum,  as  usually  paid  in  regular  serial  instalments, 
is  commonly  called  interest.  When  the  loan  is  to  be  brief  it  may 
be  paid  at  once  out  of  the  capital  borrowed.  It  is  then  called  dis- 
count. Since  it  is  in  hand,  the  rental,  or  discount,  is  absolutely 
safe. 

35.  Ideally,  interest  should  be  as  inviolable  as  principal,  and 
certain  to  be  paid  promptly,  at  regular  intervals,  and  in  predeter- 
mined amounts.  This  seems  very  trite,  but  thousands  of  investors 
have  been  misled  by  the  deception  of  the  title  into  buying  "  income 
bonds,"  simply  because  they  did  not  realize  that  security  of  prin 
cipal  and  stability  of  income  do  not  imply  each  other. 

Strange  as  it  may  seem,  there  is  no  direct  relation  between  these 
two  investment  qualities.  Mortgages,  which  rank  with  bonds  as 
to  security  of  principal,  give  far  less  assurance  of  uniform  and 
prompt  returns.  The  whole  matter  of  interest  return  is  given  fuller 
treatment  in  the  chapter  which  compares  these  two  channels  of  in- 
vestment. Improved  business  property  in  American  cities  of  size 
has  a  steady  and  usually  increasing  value  in  liquidation;  but  the 
returns  from  any  one  parcel,  in  which  the  risk  is  not  divided  by 
rentals  from  many  tenants,  are  comparatively  irregular  and  dila- 
tory. In  a  property  of  four  tenancies,  or  less,  a  single  vacancy 
causes  a  loss  in  income  of  from  25  to  100  per  cent. 

There  is  a  hospital  in  New  York  State  bonded  for  about  40  per 
cent,  of  its  cost.  It  is  not  yet  earning  any  income.  The  security 
for  the  principal  of  these  bonds  is  at  present  the  marketable  value 
of  the  land  and  buildings.  The  payment  of  the  interest  but  not  of 
the  principal  is  guaranteed  by  a  group  of  prominent  citizens  of 
the  town.  In  this  case,  security  of  principal  and  interest  are  not 
one  and  the  same;  and  the  security  of  the  principal  and  the  prompt- 
ness of  its  payment  are,  in  a  sense,  not  one  and  the  same. 

We  shall  have  something  to  say  later  about  Residuary  Estate 
Bonds.  The  principal  is  fortified  by  collateral  lien  on  beneficiary 
rights.  The  interest  is  secured  by  annuity  on  the  life  of  the 
issuer  of  the  bond,  payable  on  his  demise  to  the  owner  of  the  bond 
for  the  remainder  of  the  term  of  the  bond.  Here  again  principal 
and  interest  have  separate  and  distinct  reinforcement. 

Uniformity  and  promptness  of  return  are  greatest  in  annuity 
insurance  and  in  bonds;  promptness  without  uniformity,  in  de- 
posits with  trust  companies  and  all  kinds  of  banks.    If  stocks  and 


16  THE  ELEMENTS  OF  AN  IDEAL  INVESTMENT 

unimproved  property  are  classed  with  investments  it  must  be 
acknowledged  that  the  return  from  them  is  exceedingly  irregular,  and 
in  the  majority  of  cases  amounts  to  nothing.1 

36.  There  is  another  situation  in  which  Fixity  of  Income  in- 
terests us:  What  remedy  have  we  in  default  of  the  income? 
Obviously  none  except  when  investments  are  strictly  loans.  De- 
fault in  the  interest  of  mortgages  and  mortgage  bonds  renders  the 
principal  due,  and  thereby  furnishes  the  best  remedy:  foreclosure 
of  the  property  secured.  Default  of  payment  in  annuities,  in 
interest  on  corporation  debentures,  ipso  facto  renders  the  company 
insolvent  and  subject  to  whatever  remedy  may  be  had  in  bankruptcy 
proceedings. 

It  is  a  curious  fact,  not  so  well  known  as  it  should  be,  that 
default  in  the  interest  of  municipal  bonds  (in  most  states  merely 
debentures)  does  not  mature  the  principal;  and  since  bankruptcy 
proceedings  may  not  be  undertaken  against  municipalities,  there 
is  no  action  to  recover  except  on  the  defaulted  coupons.2 

Guaranteed  and  preferred  stocks  (and  of  preferred  stocks  especially 
cumulative  preferred)  have  better  standing  than  other  corporate 
shares  3  as  regards  fixity  of  income.  But  this  superior  standing  is 
affected  by,  and  limited  to,  the  period  for  which  dividends  on  the 
stock  are  guaranteed,  in  the  one  case,  and  to  the  duration  of  the 
stock,  if  it  is  callable,  in  the  other.  Owing  to  the  peculiar  con- 
ditions under  which  stocks  of  subsidiary  corporations  come  to  be 
guaranteed  there  is  great  probability  that  at  the  expiration  of  the 
guaranty  a  renewal  of  it  will  be  brought  about  only  by  the  lowering 
of  the  interest  rate.  Preferred  stocks  sometimes  sliare  with  common 
stocks  in  enlarged  distributions  over  the  nominal  rate.  Departure 
in  this  direction  from  fixed  income  is  certainly  no  objection.  Pre- 
ferred stocks,  on  which  dividends  must  be  paid  when  earned,  and 


1  The  return  from  even  American  railroad  stocks  is  disconcerting.  In  1892 
any  dividends  at  all  were  paid  on  only  40  per  cent.;  in  1897  on  30  per  cent.; 
in  1903  on  5G  per  cent.  For  the  same  years  interest  was  paid  on  85  per  cent., 
84  per  cent.,  and  96  per  cent.,  respectively,  of  all  bonds. 

2  No  class  of  bonds  is  less  understood  than  municipals.  Granted  that  they 
are  the  very  safest  of  investments,  it  is  remarkable  what  solemn  nonsense  is 
written  about  them  over  the  signature  of  bankers  who  make  a  specialty  of  their 
sa]e; — to    say    nothing   of    men   who    write    about    financial    matters    from    the 

outside. 

•"Corporate  stock"  of  municipalities  (a  term  borrowed  from  England)  does 
not  differ  in  essentials  from  municipal  bonds. 


THE  ELEMENTS  OF  AN  IDEAL  INVESTMENT  17 

which  may  be  retired  after  a  certain  period,  have  much  the  same 
investment  position  as  income  bonds. 

37.  For  loans  of  long  duration  there  is  involved  in  this  matter 
of  fixity  of  interest  a  more  profound  question  than  mere  certainty 
and  regularity  of  payments, — and  that  is  the  future  purchasing 
power  of  the  money  in  which  interest  is  usually  payable.  If 
dealing  in  long  loans  it  is  well  to  know  that  the  certificate  of  in- 
debtedness given  by  the  borrower  calls  for  payment  of  interest 
and  principal  "  in  gold  coin  of  the  United  States  of  the  present 
standard  of  weight  and  fineness "  rather  than  in  mere  "  lawful 
money  of  the  United  States,"  however  synonymous  these  two  terms 
may  now  seem ;  but  it  would  be  better  if  the  lender  by  any  possible 
system  of  accounting  could  exact  interest  of  so  much  per  cent. 
"  in  present  purchasing  power  of  the  necessities  of  life."  By  such 
an  impossible  provision  investment  would  rid  itself  of  one  ever- 
present  speculative  element  that  becomes  increasingly  important 
the  longer  the  life  of  the  loan. 

38.  Fair  Income  Return,.  We  have  implied  in  the  preceding 
chapter  that,  all  other  things  being  equal,  the  income  return  varies 
inversely  as  the  security.  But  all  other  things  are  not  equal — 
particularly  knowledge  on  the  part  of  the  investor  of  the  relative 
merits  of  various  classes  of  securities,  and  knowledge  of  the  effect 
of  laws  governing  the  investment  of  savings  and  trust  funds,  and 
of  other  similar  artificial  conditions  affecting  the  market  price  of 
securities.  It  is  therefore  possible,  by  studies  such  as  this  under- 
taken for  bonds,  to  make  use  of  more  intimate  knowledge,  and 
to  gain  thereby  in  income  return.  This  we  shall  again  suggest 
in  our  remarks  about  District  Bonds,  and  Equipment  Bonds,  and 
elsewhere. 

39.  Whatever  the  form  of  investment  in  which  one  is  interested, 
there  are  certain  propositions  into  which  one's  money  is  invited, 
that  by  almost  common  consent  return  less  than  even  "  perfect " 
security  has  a  right  to  command.  This  is  true  of  much  central 
business  property.  The  speculative  prospect,  or  sentimental  con- 
siderations, satisfy  investors  in  such  property.  In  business  prop- 
erty particularly,  presumptive  future  rental  power  is  capitalized. 
Insurance,  which  (to  use  a  Hibernicism)  is  composed  of  insurance 
and  investment,  yields  less  than  pure  investment,  for  the  reason 
that  nearly  all  insurance  companies  figure  the  return  on  endow- 
ments at  3  per  cent.  But  the  great  majority  of  investment  proposi- 
tions have  the  opposite  fault:   they  make  such  large  returns  as 


18  THE  ELEMENTS  OF  AN  IDEAL  INVESTMENT 

clearly  to  indicate  that  something  has  been  sacrificed,  generally 
security,  to  obtain  the  given  rate. 

Turning  now  to  bonds,  it  is  evident  that  the  income  from  our 
national  loans,  even  the  insular  issues,  does  not  represent  a  fair 
return  upon  what  most  people  consider  the  best  security:  the 
credit  of  the  Federal  Government.  It  is  equally  evident  that  when 
a  shortly  maturing  obligation  of  a  great  railroad  system  in  the 
United  States  sells  at  a  price  to  yield  15  per  cent,  there  is  grave 
doubt  in  the  minds  of  investors  as  to  whether  the  obligation  will 
be  paid  at  maturity.  Somewhere,  therefore,  between  2  and  15  per 
cent,  lies  the  income  value  of  absolutely  secure  bonds. 

The  higher  grades  of  municipal  bonds  in  this  country  are  now 
selling  at  prices  to  net  from  3.50  to  4.25  per  cent.  This  variation 
of  3-4  per  cent,  cannot  represent  that  amount  of  variation  in  se- 
curity; but  rather  it  represents,  to  a  great  degree,  the  variation 
in  intensity  of  competitive  demand  due  to  market  factors,  such 
as  exemption  from  tax,  savings  bank  and  insurance  company  de- 
mand, etc.,  factors  treated  in  greater  fullness  in  the  chapters  on 
City  and  Town  Bonds. 

40.  Shall  it  be  said  that  the  bonds  of  Spokane,  Washington, 
represent  with  approximate  correctness  the  fair  rental  value  of 
money  destined  for  pure  investment  in  bonds?  Spokane  has  a 
clean  record  for  municipal  good  faith ;  it  is  the  center  of  a  settled 
and  very  fertile  agricultural  district,  is  well  built,  and  in  good 
financial  condition,  and  is  now  well  beyond  75,000  in  population,  and 
therefore  becoming  rapidly  metropolitan  in  character.  A  minor 
drawback  is  that  its  obligations  lack  the  seasoning  a  century  of 
corporate  existence  gives.  The  consensus  of  experienced  opinion 
is  that  Spokane's  bonds  are  certain  to  be  paid — as  things  go  in  this 
world.  Since,  however,  Spokane  is  a  Far  Western  city,  and  its 
debt  considerably  more  than  5  per  cent,  of  its  assessed  valuation, 
it  is  not  a  legal  investment  for  the  savings  banks  (in  some  of  the 
Eastern  states)  that  strongly  incline  toward  the  purchase  of 
municipal  bonds;  and  for  the  same  reasons  it  is  not  particularly 
attractive  to  prejudiced  and  insular  Eastern  investors.  The  de- 
mand, then,  for  Spokane  bonds  is  not  keenly  competitive,  but  per- 
haps fairly  normal,  and  comes  from  those  who  weigh  investments 
judicially  and  decide  upon  intrinsic  merit. 

If,  then,  the  obligations  of  Spokane,  which  at  this  time  sell 
upon  a  4.25  per  cent,  basis  or  thereabouts,  represent  the  rental  value 
of  pure  investment  in  bonds,  we  have  a  standard  of  Fair  Income 


THE  ELEMENTS  OF  AN  IDEAL  INVESTMENT  19 

Return;  and  if  as  individual  investors,  we  accept  a  greater 
return,  it  must  be  either  at  the  sacrifice  of  security,  or  because 
of  investment  knowledge  or  opportunities  superior  to  those 
of  bond  buyers  in  general.  Very  probably  we  have  superior 
opportunities. 

Supposing  that  4.25  per  cent,  represents  the  present  rental  value 
of  money  to  be  placed  in  bonds  as  a  class,  the  same  gauge  may 
be  worthless  in  G  months,  and  may  not  apply  now  to  other  classes 
of  investment.  Although  3£  to  4  per  cent,  is  the  rental  value  of  a 
dollar  in  most  savings  banks  at  present,  most  people  would  believe 
these  rates  too  low  for  real  estate  mortgages. 

Nevertheless,  no  matter  how  elusive  the  standard  of  fair  return 
upon  pure  investment,  it  ahvays  exists,  and  we  buy  foolishly  and 
unscientifically  when  we  neglect  to  satisfy  ourselves  by  what  right 
or  opportunity  we  obtain  a  greater  income  from  our  investments 
than  we  have  set  for  a  standard,  since  generally  it  is  by  the  assump- 
tion of  risk. 

41.  Marketability.  But  let  there  be  no  misunderstanding.  It  is 
possible  to  get  a  greater  income  return  than  the  standard  without 
loss  in  security,  if  one  will  sacrifice  other  advantages.  It  is  the  old 
law  of  compensation  at  work.  If,  for  instance,  one  will  be  satisfied 
with  a  bond  less  widely  known  than  Spokane  debentures,  yet  with 
equal  security,  there  can  be  a  gain  in  return.  In  such  a  case  one 
may  not  be  able  to  sell  again  with  such  facility: — marketability 
may  be  impaired  for  income.  But  most  bond  buyers  demand  a 
higher  degree  of  marketability  than  they  really  need.  The  cause 
of  this  error  is  the  pernicious  confusion,  in  the  minds  of  investors, 
of  the  speculative  and  investment  functions  of  the  stock  ex- 
changes. The  generally  ill-advised  demand  for  "  listed "  bonds, 
from  private  investors  with  poorly  digested  knowledge  of  their  own 
needs,  is  one  of  the  most  exasperating  trials  that  investment 
houses  have  to  contend  with.  The  very  phrase  used  betrays  the 
difficulty.  What  they  mean  is  "  active "  bonds ;  quite  another 
thing. 

42.  And  yet  bonds  as  a  class  are  the  most  readily  salable  of  all 
the  forms  of  pure  investment  in  which  the  loan  takes  the  form 
of  a  contract  of  sale.  Mortgages  are  much  less  easily  convertible. 
Insurance  contracts  are  quick  and  certain  in  disposal,  but  always 
at  the  sacrifice  of  principal. 

43.  But  of  all  sorts  of  investments  bank  deposits  are  the  most 
quickly  convertible,  and  in  these  is  exemplified  most  clearly  the 


20  THE  ELEMENTS  OF  AN  IDEAL  INVESTMENT 

law  of  compensation.  For  the  privilege  of  withdrawal  the  lender 
of  funds  has  to  pay  dearly:  perhaps  25  to  50  per  cent,  of  his 
income  return.  This  is  marketability  at  the  expense  of  income. 
But  only  when  the  principal  is  payable  on  demand,  as  in  bank 
deposits,  is  one  fortified  with  funds  to  meet  at  his  best  unexpected 
calls  for  money.  In  savings  banks,  which  have  the  privilege  of 
withholding  depositors'  money  for  thirty  or  sixty  days,  the  com- 
pensation for  this  less  dependable  convertibility  is  a  higher  interest 
rate.  And  so  the  law  will  be  found  to  work  throughout  the  field 
of  investment,  quite  independent  of  all  considerations  of  security: 
the  price  of  convertibility  is  lessened  income. 

44.  However,  convertibility  may  be  attained  in  another  wa\ 
without  such  serious  impairment  of  income,  if  one's  invested  capital 
is  represented  by  an  instrument  for  which  there  is  a  constant  de- 
mand. Toward  this  end  active  speculation  is  in  some  respects  an 
aid  to  investment.  But  great  speculative  activity  means  great 
elasticity  of  quotations,  which  may  offset  the  good  effects  of  a 
constant  market  by  withdrawing  the  opportunity  to  sell,  at  all 
times,  at  or  near  the  purchase  price.  This  is  marketability,  or 
convertibility,  at  the  expense  of  principal.  An  ideal  market  will 
not  only  be  quick  but  steady.  An  ideal  investment  market  does 
not  necessarily  offer  chances  for  considerable  gain,  but  it  should 
be  an  influence  against  considerable  loss.  The  market  for  United 
States  bonds  has  been  for  some  time  of  such  a  sort,  and  promises 
to  be,  during  the  continuance  of  present  national  banking  laws, — 
at  the  expense  of  income. 

45.  A  good  market  may  be  "  wide  "  or  "  narrow."  Properties  or 
securities  offered  in  quantity  can  be  quickly  converted  in  a  wide 
market  without  materially  lowering  current  quotations,  providing 
the  market  is  not  only  wide  but  "  with  a  good  undertone,"  i.e.  sup- 
ported by  good  demand  at  slightly  lower  than  current  quotations. 
A  wide  market  may,  however,  be  inactive  and  weak,  and  a  narrow 
market  active  and  strong.  The  ideal  market  is  wide,  active,  and 
strong. 

The  regularity  and  uniformity  of  security  issues  gives  them  u 
marketability  impossible  to  other  kinds  of  property.  The  size  of  a 
security  issue,  and  the  character  of  the  demand  for  it,  have  more 
to  do  with  its  marketability  than  the  intrinsic  worth  of  it. 

46.  Value  as  Collateral.  When  an  unexpected  need  for  capital 
loaned  may  prove  temporary,  the  sale  of  the  investment  in  which 
the  capital  is  loaned  may  be  avoided  by  obtaining  a  loan  upon  the 


THE  ELEMENTS  OF  AN  IDEAL  INVESTMENT  21 

principal, — a  loan  upon  a  loan.  This  is  possible  without  trouble, 
expense,  or  loss  of  time,  in  only  a  very  small  proportion  of  invest- 
ments, and  sharply  draws  a  line  between  what  may  properly  be 
called  "  investment  securities,"  and  investments  in  general. 

47.  It  is  the  peculiar  distinction  of  insurance  policies  written 
in  the  better  companies  and  having  a  loan  value,  that  they  are  the 
only  paper  on  which  an  investor  has  a  reasonable  likelihood  of  being 
able  to  borrow  in  the  midst  of  a  money  panic.  And  not  only  may 
he  borrow  on  it,  but  at  no  usurious  rate  of  interest  such  as  he  would 
be  charged  by  a  bank,  if  he  could  persuade  a  bank  to  loan  at  such 
a  time.  The  amount  loaned  in  this  way  by  insurance  companies 
during  the  panic  of  1907  totaled  many  millions. 

48.  Loans  upon  mortgages  are  rare,  and  take  time  to  make, 
and  are  expensive  out  of  all  proportion  to  the  usual  amount  bor- 
rowed. The  loan  value,  or  hypothecary  value  of  bonds  exceeds  that 
of  most  other  forms  of  investment.  A  larger  amount  (commonly 
80  per  cent.)  can  be  borrowed  than  on  real  estate.  The  loan  can 
be  made  without  expense  if  acceptable  to  local  bankers;  if  not, 
there  is  an  inconsiderable  expense  in  postage,  insurance,  and  loss 
of  interest,  in  shipping  to  a  banking  center  where  the  security  is 
known.  The  interest  on  the  loan  will  vary  with  the  variation  in 
rates  for  money,  but  in  the  main  it  does  not  exceed  the  interest 
rate  of  the  bond.  This  highly  desirable  hypothecary  value  of  bonds 
is  largely  overlooked  by  professional  men  and  those  in  business  life 
who  have  little  dealing  with  banks.  The  great  system  of  American 
bond  houses  is  built  and  financed  upon  the  superior  hypothecary 
value  of  bonds. 

49.  Tax-Exemption.  Another  desirable  feature  for  an  investment 
is  exemption  from  special  tax  or  assessment.  In  the  last  analysis 
all  wealth  is  taxed,  and  it  is  a  question  only  of  the  directness  of 
its  imposition :  of  the  incidence  of  taxation,  as  the  economists  say. 
But  the  incidence  of  taxation  is  so  inequitable  that  one  may  often 
profit  by  knowledge  of  the  working  of  this  inequality,  or  at  least  se- 
cure his  investment  from  unforeseen  levies  by  the  provisions  of  his 
investment  contract,  or  by  the  provisions  of  statutory  law.1 

'The  tax  laws  of  a  state  may  relieve  bonds  of  certain  classes  from  liability  to  tax- 
ation, absolutely,  or  may  relieve  them  from  liability  on  the  doing  of  some  act  con- 
temporaneous with  or  subsequent  to  issue,  as  in  the  payment  of  an  initial  recording 
tax.  In  Pennsylvania  the  former  are  called  tax  exempt  and  the  latter  tax  free. 
This,  however,  seems  an  inversion  of  terms  from  an  etymological  standpoint.  Out- 
side of  Pennsylvania  we  know  of  no  such  distinction  that  is  accepted. 


22  THE  ELEMENTS  OF  AN  IDEAL  INVESTMENT 

If  the  mere  income  from  bond  investment  is  considered,  it  seems 
a  hardship  that  most  issues  of  bonds  may  be  taxed.  In  most 
states  more  stocks  than  bonds  are  exempt.  Bond  taxation  seems 
to  put  a  discount  upon  saving  and  a  premium  upon  the  assumption 
of  risk.  It  has  been  stated  in  a  recent  work  on  bond  investment 
that  the  burden  of  bond  taxation  is  light.  This  is  not  the  case. 
Some  time  ago  a  large  issue  of  Massachusetts  state  bonds  (tax 
exempt  in  Massachusetts)  was  sold  to  the  public  on  a  3.35  per 
cent,  basis.  Since  local  taxes  ran  about  $16.50  a  thousand,  the 
purchase  of  this  issue  was  equivalent  to  the  purchase  at  par  of 
a  taxable  5  per  cent.  bond.  A  tax  which,  if  paid,  takes  away  from 
an  investment  33  per  cent,  of  the  income  is  not  light,  or  fair. 

50.  It  may  be  that  inexperienced  buyers  of  bonds  sometimes 
misunderstand  the  tax-exemption  clause  which  usually  appears  in 
the  trust  deed  and  in  the  bond  recital,  stating  that  the  sums  due 
on  the  bond  shall  be  paid  by  the  company  "  without  deduction  from 
principal  or  interest  on  account  of  any  taxes,  assessments,  or  other 

governmental  charges  which  the Company  may  be  required 

to  pay  thereon,  or  authorized  to  retain  therefrom,  by  virtue  of  any 
present  or  future  law  whatsoever."  This  exempts  the  holder  from 
merely  the  taxes  directed  at  the  company,  and  has  nothing  to  do 
with  taxes  on  personalty. 

No  other  form  of  security  investment,  even  stock,  suffers  from 
taxation  so  generally  and  acutely  as  bonds.  The  exemption  of 
mortgages  gained  headway  throughout  the  states  long  before  the 
present  welcome  tendency  to  exempt  municipal  bonds,  and  bonds 
secured  by  mortgage  on  real  estate.  Insurance  policies  are  exempt; 
savings  bank  deposits  also. 

That  the  basis  prices  of  taxable  bonds  do  not  differ  from  those 
of  non-taxable  bonds  to  the  extent  of  the  local  tax  is  due  to  the 
old  principle  that  an  unrighteous  law  is  largely  unenforceable.  At 
the  time  the  tax-exempt  Massachusetts  3|s  were  selling  on  a  3.35  per 
cent,  basis  the  taxable  Massachusetts  3|s  were  selling  on  a  3.G5  per 
cent,  basis  instead  of  a  5  per  cent,  basis  as  they  should,  other  things 
apart.  Or,  to  put  the  case  more  fairly,  when  the  non-taxable 
Massachusetts  bonds  were  issued  they  should  have  sold  at  a  2  per 
cent.1  basis,  since  taxable  bonds  were  on  a  3.65  per  cent,  basis. 


THE  ELEMENTS  OF  AN  IDEAL  INVESTMENT  23 

51.  Exemption  from  Care.  Perhaps  the  greatest  service  rendered 
by  investment,  as  distinguished  from  speculation,  is  the  assurance 
it  gives  of  pecuniary  aid  to  those  less  capable  of  self-support  than 
he  who  has  risked  the  investment  surplus  into  being.  In  specula- 
tion, the  fittest  survive;  speculation  is  the  brute  contest  of  elemental 
forces.  Investment  protects  the  weak  against  the  strong,  and  of  the 
strong  makes  guardians  of  the  weak;  it  is  altruistic.  When  in- 
vestment purposes  are  altruistic  the  annuity  is  generally  of  more 
importance  than  the  maturity.  And  this  fact  militates,  as  we  said, 
against  our  definition  of  pure  investment,  as  a  loan,  on  the  basis 
that  a  promise  to  pay,  with  no  time  appointed,  is  not  a  promise. 

For  the  same  altruistic  reasons,  therefore,  which  make  it  highly 
desirable  that  an  investment  should  have  fixity  of  interest,  it  is 
well  that  the  investment  carry  with  it  as  little  care  and  responsi- 
bility as  possible,  especially  when  the  investor  is  seeking  to  provide 
over  a  period  of  years  for  the  improvident  and  helpless,  and  any 
who  are  without  business  experience. 

It  goes  almost  without  saying  that  bonds  and  insurance  annuities 
are  unequaled  in  the  simplicity  and  freedom  from  care  with  which 
annuity  returns  accrue  to  the  beneficiary.  Funds  on  deposit  are 
next  in  order,  and  were  it  not  for  psychological  conditions,  they 
would  have  precedence  over  bonds;  but  changing  rates  of  interest 
and  the  condition  of  the  principal,  unprotected  against  withdrawals 
by  the  beneficiary,  are  sources  of  trouble.  Registered  bonds  ordi- 
narily require  merely  the  cashing  of  checks,  of  course,  and  coupon 
bonds,  the  guarding  of  the  bonds  against  loss  or  theft,  and  the 
cutting  and  cashing  of  coupons.  Mortgages  require  attention  to 
many  other  details,  which  will  be  taken  up  in  another  chapter. 
Guaranteed  stocks  require  no  more  attention  than  bonds,  during 
the  life  of  the  guaranty;  but  unguaranteed  stocks  are  in  slightly 
less  favorable  position  owing  to  the  voting,  and  assessment  possi- 
bilities of  part  ownership,  and  to  bookkeeping  and  other  adjust- 
ments resulting  from  changing  income  return.  Real  estate  and 
other  non-loan  investments,  all  of  which  verge  on  speculations, 
cannot,  of  course,  be  compared  with  the  securities  mentioned. 

52.  Acceptable  Duration.  Closely  akin  to  freedom  from  care  is 
the  matter  of  duration.  If  a  loan  is  secure  and  has  twenty  years 
to  run,  there  are  twenty  years  of  relief  from  attention  to  it.  Few 
investors  give  enough  consideration  to  their  proper  wants  as  ex- 
pressed in  duration.  For  some  purposes,  notably  the  disposal  of 
surplus  banking  funds,  three  or  four  months'  commitment  may  be 


24  THE  ELEMENTS  OF  AN  IDEAL  INVESTMENT 

desirable,  but  ten  years'  investment  unwise.  For  testamentary 
objects,  ten  years  is  likely  to  be  too  short.  Yet  if  there  may  be 
need  of  selling  the  loan  before  maturity,  brevity  of  life  tends  to 
preserve  the  security  in  liquidation  of  the  principal.  Numerous 
types  of  bonds  offer  such  uniformity  of  security  with  variety  in 
maturity  that  bonds  as  a  class  may  unhesitatingly  be  called  the 
most  convenient  channel  of  investment  as  respects  duration. 

53.  Acceptable  Denomination.  In  academic  discussions  of  invest- 
ment virtues  the  importance  of  denomination  is  seldom  duly  em- 
phasized. It  is  evident  that  the  more  adjustable  the  denomination 
of  the  investment,  the  more  useful  the  particular  channel  which 
furnishes  it.  Banks  will  accept  deposits  in  almost  any  minute 
amount,  as  Dime  and  Five-Cent  Savings  Banks  indicate  by  their 
titles.  It  is  the  great  service  of  savings  banks  that  they  will  accept, 
and  pay  as  high  a  rate  of  interest  on  small  amounts  as  on  large  (and 
sometimes  higher).  Savings  banks  are  without  rival  as  an  invest- 
ment channel  for  those  who  have  accumulated  less  than  $500. 

One  of  the  chief  elements  of  attraction  about  the  purchase  of 
stocks  is  that  by  means  of  corporate  shares  the  most  modest  saver 
may  participate  in  proprietorship.  For  less  than  $100  one  may 
at  the  present  time  become  part  owner  of  the  largest  corporation 
in  the  world. 

54.  Bonds  rank  next  to  stocks  in  convenience  of  denomination. 
Municipals  are  seldom  to  be  had  in  less  than  $1,000  pieces,  but 
many  corporation  bonds  are  in  $500  denomination.  Although  New 
York  City  has  in  the  past  issued  pieces  as  low  as  $10  in  amount, 
and  the  Federal  Government  has  outstanding  to-day  $50  certificates, 
yet  bond  denominations  of  less  than  $500  are  still  in  the  small 
minority  with  little  likelihood  of  immediate  change.  However, 
there  has  recently  been  some  editorial  agitation  for  the  $100  par 
for  bonds;  but  this  is  not  likely  to  meet  with  general  banking 
approval  for  some  time  to  come,  since  it  entails  so  much  more 
labor  upon  the  issuer,  and  selling  cost  upon  the  vendor,  and 
therefore  cost  to  the  purchaser. 

Real  estate  mortgages  and  real  estate  itself  are  greatly  at  a  dis- 
advantage in  the  matter  of  denomination  convenient  for  invest- 
ment. 

55.  As  an  evidence  of  how  inadequately  recognized  is  the  im- 
portant part  played  by  denomination,  it  may  be  said  that  in 
amortizing  premiums  and  discounts  on  bond  purchases  it  is  the 
rule  of  the  Government  and  of  bond  mathematicians  generally  to 


THE  ELEMENTS  OF  AN  IDEAL  INVESTMENT  25 

assume  that  the  premium  or  discount,  and  the  maturing  interest, 
should  be  credited,  and  the  present  or  future  worth  of  the  invest- 
ment computed,  by  compounding  these  balances  and  increments  of 
interest  at  the  same  interest  rate  as  the  security  returns  at  the 
price  paid.  This  is  particularly  noticeable  in  investments  of  high 
yield.  In  bonds  of  this  character,  for  instance,  a  more  circumspect 
accounting  would  consider  that  a  higher  rate  of  interest  can  be 
obtained  by  a  round  thousand  dollars,  or  whatever  approximation 
of  that  amount  the  bond  costs,  than  by  a  fractional  amount,  too 
small  to  invest  in  another  like  bond;  for  to  obtain  equal  security 
and  convertibility  the  fractional  amount  must  be  put  into  the 
savings  bank  or  trust  company,  and  obtain  only  bank  interest  for 
its  use.  It  is,  therefore,  only  as  a  matter  of  convenience  or  ex- 
pediency that  one  can  justify  the  general  practice  of  computing,  at 
6  per  cent.,  the  premium  or  discount,  and  the  interest  upon  the 
interest,  to  find  the  present  worth  of  a  6  per  cent,  investment  having 
a  maturity  date,  like  a  bond.  This  matter  receives  more  convincing 
treatment  in  its  proper  place  in  the  chapter  on  The  Accountancy  of 
Bond  Investment. 

56.  Potential  Appreciation.  The  ninth  and  last  element  of  a  per- 
fect investment  considered  worthy  of  separate  treatment  is  potential 
appreciation.  To  what  extent,  if  any,  an  investor  has  a  right  to 
expect  or  hope  for  appreciation  is  a  highly  debatable  question.  Is 
appreciation  ever  the  result  of  an  inherent  quality,  or  always 
merely  of  an  accident — of  an  unforeseeable  combination  of  circum- 
stances? If  inherent,  would  it  not  be  certain,  and  therefore  would 
it  not  have  to  be  paid  for  at  the  time  of  investment,  like  all  other 
investment  virtues?  If  paid  for  there  would  be  no  gain,  or  appre- 
ciation, at  all.  If  an  accident,  then  from  the  standpoint  of  the 
investor  it  is  merely  a  speculative  possibility,  and  not  a  principle 
to  be  sought,  defined,  and  appraised.  There  seems  to  be  no  logical 
escape  from  the  horns  of  this  dilemma. 

Appreciation,  we  are  compelled  to  say,  is  not  the  manifestation 
of  an  inherent  quality,  on  the  same  plane  of  scientific  analysis  and 
treatment  as  the  nine  foregoing  qualities.  But  since  it  is  properly 
and  studiously  sought  for  in  an  investment  some  attempt  at  de- 
fining it  will  be  well  worth  while. 

57.  Appreciation,  or  increase  in  market  value,  is  the  result  of  a 
growth  in  the  competitive  demand  for  a  security,  property,  or  com- 
modity; and  this  demand  arises  in  turn  from  a  wider  recognition 
of  one  or  more  of  the  virtues  of  the  investment:  usually  that  of 


26  THE  ELEMENTS  OF  AN  IDEAL  INVESTMENT 

security.  Therefore  prospective  or  potential  appreciation  is  the 
result  of  a  temporary  condition,  rather  than  an  inherent  quality, 
but  legitimately  the  object  of  search  and  attainment  in  a  security 
since  the  discovery  of  it  merely  requires  superior  knowledge  of  all 
the  investment  qualities,  particularly  that  of  security,  and  its 
attainment  does  not  involve  any  risk,  and  is  not  at  the  expense  of 
the  other  desirable  elements. 

58.  The  possibilities  of  appreciation  in  speculation  are  without 
limit;  in  a  pure  investment  they  are  curtailed  by  the  fact  that  at 
maturity  only  the  face  value  is  returned.  A  strange  misappre- 
hension exists  with  regard  to  the  relation  of  appreciation  to  dis- 
count, and  of  depreciation  to  premium,  in  an  investment.  Many 
people  refuse  to  buy  a  bond  selling  at  a  premium  because  they 
feel  that  they  are  losing  money  in  the  long  run  in  so  doing.  And 
from  similar  reasoning  they  much  prefer  to  buy  a  20-year  4  per 
cent,  bond  at  93.45,  rather  than  a  20-year  5  per  cent,  bond  at  106.55, 
although  the  net  return  is  the  same.  The  illusion  of  the  discount 
deceives  them.  And  there  is  no  gainsaying  that  this  very  general 
illusion  causes  a  4  per  cent,  bond  to  sell  relatively  nearer  to  par 
(i.e.  at  a  lower  net  income)  than  the  5  per  cent,  bond  of  similar 

character  and  worth. 

59.  Now  there  is  a  valid  reason  why  all  sorts  of  investors  may 
prefer  discount  to  premium  bonds:  because  they  do  not  under- 
stand how  to  amortize  the  premium  or  discount,  as  the  case  may  be. 
If  it  is  a  premium  that  is  disregarded  or  inadequately  charged  off, 
the  owner  of  the  security  is  periodically  drawing  a  portion  of  his 
principal  as  interest,  and  therefore  at  maturity  he  is  left  with  less 
principal  than  he  had  in  the  first  place;  whereas,  if  it  is  a  discount 
that  is  inadequately  amortized,  the  owner  will  receive  less  income, 
to  be  sure,  than  he  is  entitled  to  from  year  to  year,  but  at  maturity 
he  will  have  more  principal  (including  undistributed  interest)  than 
at  first.  In  brief,  an  unamortized  premium  eats  into  capital  to  the 
benefit  of  "  interest,"  but  an  unamortized  discount  adds  to  capital 
by  saving  out  of  interest.  State  laws  concerning  the  amortization 
of  premiums  and  discounts  betray  a  woeful  lack  of  bookkeeping 
knowledge. 

Hence  there  is  a  legitimate  disinclination  on  the  part  of  an  in- 
vestor, particularly  if  he  is  a  trustee  and  amenable  to  state  laws 
governing  fiduciary  investment,  toward  the  purchase  of  premium 
bonds,  and  a  preference  for  discount  bonds;  but  few  investors  dis- 
tinguish between  this  legitimate  preference,  which  is  due  to  un- 


THE  ELEMENTS  OF  AN  IDEAL  INVESTMENT  27 

familiarity  with  accounting,  and  the  ill-grounded  preference,  which 
is  due  to  a  misunderstanding  of  the  nature  of  appreciation  and 
depreciation. 

There  is  no  appreciation  in  the  fact  that  a  bond  bought  to-day 
at  95  will  be  worth  100  in  ten  years  at  maturity.  Appreciation 
is  a  gain  in  market  value;  but  the  market  value  of  an  interest- 
bearing  loan  cannot  be  measured  in  mere  dollars  and  cents.  There 
may  be  appreciation  in  a  premium  bond,  and  yet  a  loss  in  dollars 
and  cents  selling  price.  There  has  been  appreciation  in  a  G  per 
cent,  bond  bought  at  107.79  with  ten  years  of  life  to  run,  that  five 
years  later  is  sold  for  105,  for  on  the  same  basis  on  which  it  was 
bought  it  is  worth,  when  sold,  only  101.38.  Those  to  whom  this  is 
not  clear  are  referred  to  Chapter  XXXIV. 

60.  The  only  true  basis  of  worth  is  the  net  return  in  income,  as 
every  bond  man  knows.  All  bond  issues  (it  is  particularly  notice- 
able in  municipals)  are  figured  for  purchase  and  sale  from  the 
income  percentage  basis.  A  45-year  New  York  City  4  is  al- 
ways worth  more  in  dollars  and  cents,  when  New  York  City  4s 
are  selling  at  a  premium,  than  a  40-year  New  York  City  4.  But 
the  real  worth  of  the  two  maturities  is  practically  the  same,  and 
is  measured  in  terms  of  the  percentage  of  return  upon  the  invest- 
ment. New  York  City  long  term  4s,  whether  40  or  45  years,  are 
worth  a  3.80  basis,  or  a  4.10  basis,  or  whatever  the  fact  may  be. 

Therefore,  to  repeat,  there  is  no  real  appreciation  in  the  mere  re- 
tirement at  maturity  of  a  loan  bought  below  par,  since  the  monetary 
difference  between  the  cost  and  par  was  reckoned  in  figuring  the 
basis  price  upon  which  the  security  was  bought.  At  least  this  is 
invariably  the  case  in  the  purchase  of  bonds,  all  the  price  tables 
for  which  take  the  discount  into  accurate  consideration.  The  cost 
prices  of  all  investment  securities  which  are  scientifically  bought 
are  figured  upon  the  basis  of  their  net  return  at  the  given  price. 

61.  This  chapter  will  have  missed  its  aim  if  it  does  not  impress 
the  fact  that  there  are  numerous  desirable  qualities  to  be  sought 
in  an  investment,  but  that,  to  a  certain  extent,  they  conflict  with 
one  another.  It  is  for  an  investor  to  determine  what  are  his  essen- 
tial needs,  and  then  seek  an  investment  in  which  the  qualities  are 
most  prominent  which  coincide  with  his  needs.  He  should  then 
be  content  with  whatever  degrees  of  the  other  qualities  he  can 
obtain. 

We  may  say  then,  in  summary,  that  any  investment  which  will 


28  THE  ELEMENTS  OF  AN  IDEAL  INVESTMENT 

measure  up  to  the  standard  of  these  qualities  mentioned,  is  well- 
nigh  ideal.  If  an  investor  has  obtained  (1)  security  for  his  principal, 
(2)  a  fixed  or  definite  interest,  (3)  a  fair  return  in  income,  and  (4) 
an  investment  which  is  salable  without  difficulty,  and  (5)  is  accept- 
able as  collateral,  and  (G)  is  free  from  direct  tax,  and  (7)  requires 
almost  no  care,  and  (8)  matures  after  a  satisfactory  lapse  of  time, 
and  (9)  is  in  convenient  units  of  denomination,  and  (10)  has  as 
good  a  chance  of  appreciating  as  of  depreciating  as  its  qualities 
become  more  generally  recognized, — that  man  is  to  be  felicitated. 
It  will  be  instructing  to  apply  these  tests  in  any  comparison  of 
securities  that  we  shall  have  occasion  to  make  as  our  work 
progresses. 

62.  The  three  investment  qualities  that  receive  the  most  investi- 
gation are  security,  income,  and  marketability.  Obviously  all  three 
cannot  exist  in  a  high  degree  in  the  same  investment.  If  the  in- 
vestment is  thoroughly  safe  it  cannot  return  a  high  rate  of  interest, 
or  rental,  and  at  the  same  time  have  a  broad  and  active  market, 
for  such  a  market  implies  competitive  demand,  and  the  competition 
for  a  security  which  was  at  once  safe  and  of  high  yield  would 
immediately  bid  up  the  price  and  thus  lower  the  yield. 

But  if  through  ungrounded  prejudice  or  lack  of  knowledge  a 
security  is  without  vogue  and  has  to  be  sold  by  personal  solicitation, 
it  may  be  both  safe  and  of  high  return.  It  is  the  principal,  and  m 
every  way  commendable  function  of  tlie  better  American  bond 
houses  to  sell  to  their  clients  issues  of  bonds  which  Iiave  unim- 
peachable security  and  yet  an  income  return  considerably  higJier 
than  would  be  the  case  were  the  issues  well  known  to  the  investing 
public  at  large. 


CHAPTER  IV 
STOCKS  VERSUS  BONDS 

63.  Since  stocks  are  the  typical  speculative  paper  and  bonds 
the  typical  investment  security,  it  is  manifestly  unfair  to  measure 
them  both  by  the  investment  standard  to  the  predetermined  dis- 
paragement of  stocks.  But  on  the  other  hand  stocks,  as  a  class, 
are  so  generally  thought  of  as  investments,  and  the  distinction  be- 
tween investment  and  speculation  is  so  inadequately  recognized, 
that  a  contrast  of  stocks  with  bonds  as  channels  for  pure  investment 
may  be  worth  while,  even  if  the  conclusion  is  foregone. 

The  comparison  may  well  take  the  form  of  a  test  by  the  nine  or 
ten  postulates  of  our  ideal  investment,  beginning  with  Security 
of  Principal. 

64.  Security  of  Principal.  From  which,  stocks  or  bonds,  is  a  man 
most  sure  of  recovering  the  funds  he  has  once  relinquished?  This 
question  of  itself  involves  no  matter  of  profit,  or  of  income,  but 
merely  of  recovery.  The  answer  lies  in  the  very  nature  of  stocks 
and  bonds.  Legally,  a  share  of  stock  is  a  certificate  of  ownership 
of  a  corporation.  Unless  otherwise  stipulated,  it  represents  a  right 
to  pro  rata  participation  in  control,  in  profits,  and  (if  the  corpora- 
tion liquidates)  in  whatever  assets  are  unattached.  But  although 
a  share  of  stock  represents  part  ownership  in  a  corporation,  and  the 
right  to  participate  in  profits,  it  does  not  represent  any  property 
except  this  right. 

65.  Most  people  fail  to  comprehend  the  meager  property  rights 
of  stock,  hence  all  the  nonsense  and  farrago  about  stock  water 
ing, — as  if  there  were  or  should  be  some  inherent  significance  to  the 
par  value  of  stock ;  or  that  the  par  value  should  represent  so  manj 
dollars  paid  in.  The  par  value  of  bonds,  even,  does  not  signify  any 
definite  payment  in  purchase.  Most  people  seem  to  think  that 
a  certificate  of  stock  is,  or  should  be,  equivalent  to  a  cashier'a 
check,  which  certifies  to  a  deposit  of  money  equal  in  value  to  the 
face  of  the  check,  or  of  a  warehouse  receipt  calling  for  the  delivery 
of  some  commodity  equal  in  weight  or  quantity  to  the  amount  of 
the  receipt.    There  is  nothing  in  the  legal  nature  of  stock  to  give 

29 


30  STOCKS  VERSUS  BONDS 

the  ownor  cause  to  look  to  the  company's  assets  for  the  full  recovery 
of  his  principal. 

Except  in  bank  stocks,  recovery  in  liquidation  seldom  amounts 
to  more  than  the  merest  fraction  of  the  sum  invested ;  for  ordinarily 
corporations  expire  only  because  of  their  inability  to  do  business 
at  a  profit;  and  the  equitable  interest  in  unprofitable  property, 
which  survives  the  prior  demands  of  creditors,  cannot,  as  a  rule, 
amount  to  much,  so  long  as  corporations  are  financed  largely  by  the 
sale  of  obligations,  secured  or  unsecured.  When,  as  nowadays,  not 
only  the  rights,  franchises,  and  physical  proper!  ie^  but  even  the 
very  shares  of  the  corporation,  are  pledged  to  secure  bor- 
rowed money,  the  stockholder  has  little  to  expect  under  the 
hammer. 

Security  of  Principal  in  a  stock  investment  is  further  lessened 
to  the  extent  that  the  shares  are  subject  to  assessment. 

66.  The  only  resource  for  the  recovery  of  principal  in  stock 
purchases  is  sale.  Two  questions  then  arise :  is  there  a  market  for 
the  stock;  and  will  it  sell  for  more  or  less  than  cost?  Market- 
ability of  stock  will  be  discussed  in  its  turn.  As  to  market  prices, 
stocks,  in  keeping  with  their  speculative  character,  fluctuate  more 
widely  than  bonds. 

If  the  stock  is  bought  at  an  average  price  (assuming  such  a  price), 
and  its  intrinsic  worth  remains  undiminished,  the  investment  can 
be  recovered  by  sale  a  fair  portion  of  the  time.  But  if  its  intrinsic 
worth  lessens  or  disappears,  the  possibility  of  sale  at  cost,  or  better, 
diminishes  or  vanishes,  taking  with  it  any  element  of  security  for 
the  principal.  So,  in  the  last  analysis,  Security  of  Principal  de- 
pends upon  the  permanency  of  equitable  assets  having  a  pro  rata 
value  equal  to  the  cost  of  the  stock. 

67.  Bonds,  on  the  other  hand,  represent,  in  the  majority  of 
cases,  an  investment  by  the  obligor  of  an  amount  at  least  equal  to 
their  cost.  Not  legally  but  in  fact,  they  correspond  with  reasonable 
accuracy  in  the  comparison  to  cashier's  checks  and  warehouse  re- 
ceipts. Although  the  amount  of  debenture  obligations  is  growing 
rapidly,  nevertheless  it  is  small  in  comparison  with  the  amount 
of  bonds  that  have  the  backing  of  mortgage  or  collateral.  The 
principal  of  bonds,  therefore,  is  usually  fortified  by  actual  repre- 
sentative assets  on  which  it  has  a  prior  claim,  and  the  bondholders 
as  a  class  are  secured,  or  at  least  preferred  creditors. 

68.  Stability  of  Income.  Just  as  a  knowledge  of  the  relative  legal 
status  of  stocks  and  of  bonds  makes  clear  the  superior  security  for 


STOCKS  VERSUS  BONDS  31 

bond  principal,  so  an  understanding  of  the  economic  nature  of  each 
makes  clear  the  necessarily  inferior  stability  of  dividends  as  com- 
pared with  interest  payments. 

Economically,  stocks  represent  shares  in  the  corporate  risk.  If 
shareholders  have  contributed  all  the  capital  their  dividends  rep- 
resent, in  part,  the  return  on  invested  capital,  since  a  company  doing 
business  in  good  faith  must  have  some  assets  realizable  under  any 
conditions.  Even  when  shareholders  have  contributed  all  the 
capital,  the  returns  are  bound  to  vary  from  year  to  year  and  to 
show  maxima  and  minima  of  net  earnings.  The  difference  between 
high  and  low  earnings  represents  the  reward  to  the  speculated 
capital.  The  inevitableness  of  high  and  low  tides  of  income  often 
obtains  recognition  in  the  share  capitalization,  by  the  classifications, 
Preferred  and  Common  Stock. 

69.  Whether  the  capitalization  consists  merely  of  the  share 
liability,  or  of  shares  and  funded  debt,  the  two-fold  nature  of  the 
returns  can  be  compared  to  the  returns  on  capital  invested  in  real 
property.  A  man  may  buy  a  piece  of  real  estate  with  a  mortgage 
for  two-thirds  of  its  value.  The  surplus  income  from  the  property, 
after  payment  of  taxes,  repairs,  insurance,  and  interest  on  the  mort- 
gage, is  his  premium  for  the  assumption  of  risk.  He  is  entitled 
to  greater  return  on  his  speculated  capital  than  the  mortgagee,  who 
takes  little  or  no  risk. 

70.  In  like  manner  it  is  easy  to  provide,  in  a  spirit  of  conserva- 
tism, for  the  stability  (i.e.  not  only  for  the  security,  but  for  the 
regularity  and  uniformity)  of  the  interest  charges  of  a  company, 
when  it  is  bonded,  and  when  legal  distinctions  exist  between  the 
classes  of  its  capitalization.  But  to  the  extent  that  earnings  vary, 
the  dividends  may  properly  adjust  themselves  to  preserve  the  in- 
tegrity of  the  surplus,  and  for  the  disadvantages  to  which  the  share- 
holder is  subjected  by  this  adjustment  he  should  be  recompensed  by 
high  returns  upon  his  capital,  if  they  are  possible. 

When  the  dividend  rate  is  less  than  the  interest  rate  of  the  same 
company  it  is  no  sign  that  the  shareholder  is  not  being  reimbursed 
so  fully  as  the  bondholder  because  the  so-called  par  value  of  stock 
approximates  less  truly  than  the  par  value  of  bonds  the  amount  of 
capital  committed. 

A  table  of  comparisons  will  readily  show  how  much  more  sus- 
ceptible to  unfavorable  influences  are  the  dividends  of  a  corpora- 
tion than  the  interest  payments.  We  suppose  a  company  capitalized 
with  $700,000  outstanding  bonds,  |250,000  Preferred  Stock,   and 


32  STOCKS  VERSUS  BONDS 

1650,000  Common.    The  ratios  assumed  in  capitalization  and  earn- 
ings will  not  be  thought  unusual. 


GOOD  TIMES 

NORMAL   TIMES 

HARD  TIMES 

Net  Earnings 

$150,000 

$100,000 

$60,000 

Bond  Interest     (5%) 

$35,000 

$35,000 

$35,000 

Pref'd  Stock       (6jQ 

15,000 

15,000 

(4%)  10,000 

Common  Stock  (8#) 

52,000 

(4j0  26,000 

(-)    -- 

102,000 

76,000 

45,000 

Balance  for  Surplus,  etc.         $48,000  $24,000  $15,000 

In  good  times  each  of  the  three  classes  of  capital  is  paid  some- 
thing like  a  fair  return  upon  par.  If  these  three  income  accounts 
represent  three  consecutive  years,  it  will  be  seen  that  funded  debt 
has  been  paid  15  per  cent.,  preferred  stock  16  per  cent.,  and  common 
12  per  cent.  If  these  three  years  were  representative,  the  common 
might  be  considered  unfortunately  situated ;  but  we  must  remember 
that  a  common  stock  subject  to  such  fluctuations  in  return,  or  to 
such  a  low  average  of  return,  would  probably  cost  less  than  par  and 
would  represent  less  than  $100  per  share  of  capital  paid  in;  there- 
fore the  nominal  annual  return  would  be  much  less  than  the  real. 

In  hard  times,  when  earnings  decline  and  the  "  margin  of  safety  " 
narrows,  and  even  bond  interest  is  threatened,  the  equities  in  earn- 
ings, charged  to  dividends  and  balances,  will  be  adjusted  to  preserve 
the  integrity  of  the  interest  as  long  as  possible.  Interest  must 
always  be  supported  at  the  expense  of  dividends. 

71.  Although  stability  of  interest  has  more  to  do  with  the 
economic  than  with  the  legal  position  of  bonds,  nevertheless  the 
latter  has  its  marked  effect.  In  the  trust  agreement  of  bond  issues, 
whether  mortgage  or  debenture,  precaution  is  usually  taken  to  pre- 
vent the  creation  of  future  indebtedness  that,  in  whole  or  in  part, 
could  become  a  lien  prior  to  the  obligations.  In  the  nature  of 
corporations  there  can  lie  nothing  to  prevent  the  stockholders  who 
are  in  control  from  imposing  on  the  company  obligations  that 
shall  be  a  charge  upon  revenues  to  be  met  before  dividends  are 
paid. 

72.  In  considering  securities  by  types  and  classes  there  is  a  nat- 
ural tendency  to  have  in  mind  the  more  prominent  issues  listed  on 
the  leading  exchanges.  Yet  listed  securities,  but  particularly  listed 
stocks,  are  not  thoroughly  representative  of  their  classes.  There- 
fore if  it  is  the  common  practice  to  lower  the  dividends  on  our 
best  listed  stocks  it  is  a  fair  inference   (supported  by  the  facts) 


STOCKS  VERSUS  BONDS  33 

that,   in   general,    reserves   are   not   sufficiently   strong   to   relieve 
dividends  of  their  natural  office  in  the  income  account. 

During  the  first  nine  months  of  business  depression  following 
the  panic  of  September,  1907,  the  dividends  of  80  large  railroad  and 
industrial  corporations  were  passed  or  reduced.  Sixteen  railroads 
passed  their  dividends ;  among  them  the  Missouri  Pacific,  the  Cleve- 
land, Cincinnati,  Chicago,  and  St.  Louis,  the  Southern  Railway,  the 
Erie,  and  the  Lake  Erie  and  Western.  Ten  prominent  railroads 
reduced  their  dividends;  including  the  Pennsylvania,  New  York 
Central,  Atchison,  Louisville  and  Nashville,  Norfolk  and  Western, 
and  Atlantic  Coast  Line.  Twenty-six  prominent  industrial  cor- 
porations omitted  dividends  entirely  and  twenty-nine  radically  re- 
duced them. 

73.  Frequently  dividends  are  passed,  or  cut,  or  the  proper  rate 
is  not  declared,  to  serve  the  ends  of  an  irresponsible  directorate. 
The  minority  shareholders  have  almost  no  voice  in  the  matter. 
Recently  determined,  but  not  altogether  successful  attempts  have 
been  made  in  the  courts  by  shareholders  in  rich  corporations, — 
such  as  the  express  companies. — to  make  these  companies  disgorge 
some  of  the  accumulated  profits.  In  illustration  of  the  extent  to 
which  this  kind  of  injustice  can  be  carried, — some  time  ago  the 
owners  of  one  of  the  large  packing  houses  of  the  country  sought, 
by  quiet  stock  purchases  in  the  open  market,  to  obtain  control  of 
another  packing  house;  but  their  plan  was  frustrated  before  they 
acquired  a  majority  of  the  shares.  In  retaliation  those  who  control 
the  latter  house  have  paid  no  dividends,  although  40  per  cent,  is 
being  earned  on  the  stock,  but  have  recompensed  themselves  by 
princely  salaries.  The  would-be  purchasers  of  the  control  are  in 
the  situation  of  the  hunter  who  held  the  lion's  tail,  and  didn't 
know  whether  to  hang  on  or  let  go.  Meanwhile  the  small  share- 
holder has  his  moral.  But  both  companies  have  always  promptly 
paid  the  interest  on  their  outstanding  debts.  The  courts  would 
speedily  find  relief  for  a  minority  note  or  bond-holder  who  was 
deprived  of  his  return  in  the  evolutions  of  the  conflict. 

74.  Fair  Income  Return.  Since  the  shareholder,  not  the  bond- 
holder, assumes  the  main  hazard  of  corporate  enterprise,  his  return 
in  dividends,  immediate  or  prospective,  should,  in  general,  exceed  the 
interest  returns  by  that  ratio  which  fairly  represents  the  relative 
risk  to  the  two  classes  of  capital.  Any  expression  of  opinion  as  to 
whether  he  does,  in  the  long  run,  obtain  this  relatively  fair  return 
must,  at  present,  be  purely  personal.    Any  one  with  a  taste  for  fig- 


34  STOCKS  VERSUS  BONDS 

ures  and  ample  leisure  for  investigation  might  ascertain  the  facts 
hevond  cavil  for  listed  securities;  but  to  do  so  he  must  institute  an 
elaborate  system  of  constantly  changing  costs  (or  market  prices)  for 
stocks  and  bonds  and  corresponding  net  returns  upon  cost. 

75.  No  attempt  is  made  here  to  prove  anything  by  figures,  but  it 
may  be  a  matter  of  interest  to  note  that  the  more  important  cor- 
porations of  the  country  have  made  less  return,  during  the  past 
decade,  on  the  par  value  of  their  share  capital  than  on  that  of 
their  bonds. 

Many  causes  may  be  assigned  as  influential  in  this  result,  notably 
the  fact  that  the  cost  of  bonds  has  represented  a  larger  percentage 
of  parity  than  the  cost  of  stocks,  and  that  the  superior  marketability 
of  stocks  largely  offsets  the  inferior  security  and  has  to  be  paid  for 
in  increased  cost  or  lessened  return ;  but  the  writer  believes  that  the 
dividend  averages  below  represent  frustrated,  or  at  least,  unfulfilled 
hopes : 

THE  AVERAGE  RETURN  OP  TWO  DOZEN  REPRESENTATIVE  RAILROAD  STOCKS 

FOR  TEN  YEARS 


Common  Stock.  . .  .less  than  2£  per  cent. 
Preferred  Stock. .  .less  than  3^  per  cent. 


Average  2£  per  cent. 


THE  AVERAGE  RETURN  OF  A  DOZEN  REPRESENTATIVE  INDUSTRIAL 

CORPORATIONS 


Preferred  Stock ....  about  6  per  cent. 
Common  Stock about  3  per  cent. 


Average  4£  per  cent. 


If  these  averages  have  any  significance  they  confirm  the  mature 
judgment  quoted  in  the  second  chapter  (§24),  that  "  larger  gains 
are  to  be  made  by  investment  than  by  speculation,  so  far  as  the 
non-professional  is  concerned." 

76.  Marketability.  We  have  just  stated  that  the  superior  market- 
ability of  listed  stocks  over  listed  bonds  was  part  cause  of  the 
low  average  return  upon  the  cost  price  shown  by  the  stocks  in  the 
above  table.  But  again,  let  it  be  remembered  that  listed  securities 
in  general  are  in  the  minority,  and  are  by  ao  means  representative 
for   illustration   of   investment   principles.     The   tendency   to   use 


STOCKS  VERSUS  BONDS  35 

them  is  natural  because  board  transactions  are  recorded,  and  easily 
accessible  for  reference. 

77.  There  is  no  statistical  means  of  proving,  among  unlisted 
securities,  the  superior  marketability  of  bonds  over  stocks,  but  the 
writer's  personal  testimony,  based  on  professional  duties,  no  small 
part  of  which  has  been  to  find  markets  throughout  the  country 
for  unlisted  and  inactive  securities,  is  that  bonds  are  more  easily 
sold  than  stocks. 

This,  too,  is  the  natural  inference  from  the  superior  intrinsic 
worth  of  bonds,  and  from  the  fact  that  investment  conditions  are 
more  uniform,  and  can  be  more  easily  and  generally  recognized,  than 
speculative  conditions.  The  article  of  superior  and  acknowledged 
merit  will  be  the  more  readily  disposed  of. 

78.  The  American  bond  market, — that  is,  the  bond  market  in 
Canada  and  the  United  States, — is  an  institution  without  parallel 
in  other  countries.  Although  the  discussion  of  this  market  comes 
more  properly  under  other  heads,  such  as  The  Bond  Houses  and 
Listed  Versus  Unlisted  Bonds,  it  is  fitting  to  state  that  the  American 
bond  market  is  the  basis  of  a  special  business  that  encourages 
professional  knowledge  of  values  and  seeks  selling  places  for  the 
multitudinous  issues.  The  result  is  a  broader  and  quicker  response 
to  bond  offerings  than  the  unlisted  stock  market  furnishes  foe 
stocks. 

79.  Hypothecary  Value.  The  value  of  any  security  as  collateral 
depends  mainly  on  its  market  and  its  worth.  In  general,  a  listed 
security  is  more  acceptable  as  collateral  than  an  unlisted,  because 
current  quotations  are  an  easily  accessible  index  of  current  values 
and  the  frequency  and  volume  of  sales  are  an  indication  (although 
not  always  reliable)  of  the  breadth  and  responsiveness  of  the 
market.  The  more  actively  dealt  in  a  security  is,  the  less  neces- 
sary is  a  knowledge  of  its  intrinsic  worth  as  the  basis  of  loan. 

For  this  reason  listed  bonds  have  no  advantage  over  listed  stocks, 
especially  when  hypothecated  in  New  York.  The  loan  clerks  of  the 
New  York  banks  that  cater  to  brokerage  houses  are  too  likely  to 
make  loans  with  an  eye  solely  to  the  quotations  of  the  day.  When 
these  quotations  are  fictitious  the  result  of  a  quick  collapse  in  prices 
is  sometimes  disastrous.  It  goes  far  to  explain  the  comparative 
acuteness  of  money  crises  in  New  York. 

The  interior  banks,  which  perform  banking  functions  more  prop- 
erly than  the  metropolitan  banks,  ordinarily  give  more  attention  to 
the  merit  of  investments.     If,  in  general,  the  security  and  market- 


36  STOCKS  VERSUS  BONDS 

ability  of  bonds  are  superior  to  that  of  stocks,  it  is  the  natural  and 
correct  inference  that  bonds,  in  general,  are  the  more  acceptable 
collateral. 

80.  Tax  Exemption.  As  regards  the  burden  of  taxation  very 
few  people  realize  the  great  disadvantage  under  which  bonds  labor; 
for,  although  in  no  state  are  all  bonds  unequivocally  free  of  tax, 
in  39  states  and  territories  shares  of  stock  may  not  be  assessed 
against  shareholders  when  the  issuing  corporation  or  its  property 
is  directly  taxed. 

Only  Delaware,  Georgia,  Louisiana,  and  Washington  assess  share- 
holders quite  irrespective  of  the  corporation  tax;  but  Maryland, 
the  District  of  Columbia  (in  a  measure),  Alabama,  and  Iowa  assess 
shareholders  on  that  part  of  the  value  of  their  stock  which  represents 
the  excess  of  its  market  value  over  the  assessed  value  of  the  prop- 
erties. The  legal  theoiw  is  that  this  excess  represents  otherwise  un- 
taxed good-will  and  other  intangible  property. 

The  fact  that  government  bonds  are  free  from  tax  to  individuals 
within  the  country  is  of  little  avail  because  of  their  prohibitive 
price.1  However,  the  insular  issues,  the  Philippines,  Hawaiians,  and 
Porto  Ricans,  are  tax  exempt  and  sell  on  approximately  an  invest- 
ment basis.  The  bonds  of  states  are  now  very  commonly  exempt  to 
holders  within  the  given  state,  and  the  proportion  of  municipal 
bonds  exempt  under  the  same  conditions  is  steadily  growing.  In 
fact  the  tendency  to  exempt  both  bonds  and  stocks  seems  as  in- 
evitable as  it  is  welcome. 

But  as  conditions  now  are,  personal  property  taxes  work  greater 
hardship  to  bondholders  than  to  stockholders,  for  the  demand  for 
tax-free  bonds  is  greater  than  for  tax-free  stocks,  since  bonds  are 
the  staple  investment  of  institutions  and  trustees  whose  holdings 
come  under  the  cognizance  of  courts  and  state  officials. 

81.  Freedom  from  Care.  So  far  as  the  mere  instruments  are  con- 
cerned, stocks  and  bonds  are  about  on  parity  in  regard  to  care. 
Loss  of  either  security  is,  at  the  most,  a  matter  of  mere  inconveni- 
ence. But  a  coupon  bond  is  negotiable  and  passes  by  delivery. 
Therefore  it  should  be  guarded  as  carefully  as  currency. 

As  to  freedom  from  care  in  the  larger  sense,  ownership  carries 
with  it  the  major  responsibility,  and  the  degree  of  individual 
thought  or  anxiety  should  conform  to  the  degree  of  investment 
risk. 

1  Even  the  interest  from  government  bonds  is  included  in  the  income  on  which 
corporations  are  assessed. 


STOCKS  VERSUS  BONDS  37 

82.  Acceptable  Duration.  The  test  of  acceptability  in  the  dura- 
tion, or  life,  of  the  investment,  cannot  be  applied  in  this  compari- 
son, since  stocks,  ordinarily,  have  no  maturity.  A  discussion  of 
duration  must  resolve  itself  into  a  question  of  marketability,  on 
which  we  have  already  commented. 

83.  Acceptable  Denomination.  To  the  large  majority,  the  possi- 
bility of  having  funds  invested  in  small  denominations  is  a  great 
advantage.  Occasionally  a  big  investor  or  corporation  objects  to 
$500  pieces  and  eagerly  seizes  upon  $5,000  bonds  like  the  Pennsyl- 
vania notes  of  1910,  so  as  "  not  to  clutter  up  the  safety  deposit  box." 
But  registered  bonds  and  stock  certificates  have  another  advantage 
in  common,  in  that  one  certificate  may  serve  for  any  denomination. 
Although  whatever  advantage  there  is  lies  with  stocks,  inelasticity 
of  denomination  is  not  so  marked  as  in  the  case  of  mortgages, 
which,  as  channels  of  investment,  suffer  severely  from  this  limita- 
tion. 

84.  Appreciation.  The  economic  and  legal  positions  of  bonds  and 
stocks,  which  throws  the  onus  of  risk  on  stocks  and  lessens  their 
security  of  both  principal  and  interest,  will  bring  commensurate 
possibilities  of  appreciation.  The  very  nature  of  a  loan  precludes 
great  possibilities  of  advance  in  price,  as  we  have  noted  and  shall 
note  elsewhere.  An  exception  may  be  taken  for  loans  which  are 
convertible  into  stocks.  In  the  chapter  on  The  Range  of  Bond 
Prices,  the  possibilities  for  rising  bond  prices  will  be  canvassed. 

85.  For  this  place  it  is  sufficient  to  say  that  meritorious  Ameri- 
can stocks  have  a  better  prospect  for  a  high  level  of  prices  during 
the  coming  decade.  In  some  degree  this  is  due  to  a  purchasing 
power  for  gold  that  is  still  on  the  decrease,  but  more  particularly  to 
the  fact  that  the  North  American  states  are  still  immature  in  their 
physical  and  industrial  development.  The  price-average  of  stand- 
ard listed  American  stocks  has  advanced  very  rapidly  during  the 
past  ten  years.  German  and  French  securities  of  the  same  type 
have  barely  held  their  own,  and  English  stocks  have  steadily  de- 
clined. 

86.  Probably  it  is  because  of  a  national  confidence  in  the  future 
of  corporate  activity,  that  with  necessarily  inferior  security  stocks 
appear  to  have  made  a  comparatively  low  return  to  investors.  There 
have,  indeed,  been  rich  speculative  rewards  in  stocks,  but  a  large 
part  of  them  have  gone  to  the  professional  few.  All  the  safeguards 
with  which  business  practice  and  law  can  surround  securities  are 
none  too  many  for  "  the  average  investor." 

265789 


CHAPTER  V 
THE  CHANNELS  OF  INVESTMENT 

87.  We  have  commented  in  a  general  way  on  the  merits  of  specu- 
lation and  investment  as  methods  of  gain.  We  have  studied  stocks 
and  bonds  as  most  typical,  in  this  day,  of  the  respective  methods. 
We  have  concluded  that  more  satisfactory  gains  are  derived  from 
investments  than  from  speculations.  To  disarm  criticism,  let  it  be 
said  that  some  properties  and  securities,  nominally  speculations,  are 
really  investments.  Pennsylvania  Railroad  stock,  with  a  record  of 
uninterrupted  dividend  for  50  years,  and  with  relatively  slight 
variations  in  the  dividend  rate,  is  almost  a  pure  investment  when 
bought  at  a  low  price  so  that  it  is  convertible  without  loss  most  of 
the  time,  and  will  return  4  per  cent,  or  better  even  when  dividends 
are  at  the  minimum. 

With  the  understanding,  then,  of  what  is  meant  by  investment 
in  distinction  from  speculation,  the  discussion  is  hereafter  con- 
fined to  bonds ;  except  that  a  preliminary  word  is  in  order,  outlining 
the  principal  channels  of  pure  investment,  of  which  the  main  is 
bonds. 

88.  Starting  with  the  premise  that  all  pure  investments  are 
loans,  then  all  investment  securities  are  credit  instruments,  or  con- 
tracts for  the  future  delivery  of  money. 

89.  Investments  Classified  by  the  Nature  of  the  Interest.  Since 
there  can  be  no  contract  without  consideration,  loans  may  be 
divided  according  to  the  nature  of  this  consideration  into  (a)  those 
with  no  monetary  rental  value,  (b)  those  with  fixed,  periodic  rental 
or  interest,  and  (c)  those  with  indeterminate  time  or  rate  of  interest 
payment. 

(a)  Credit  balances  in  open  accounts  are  a  form  of  commercial 
credit  that  may  be  transferred  by  what  amounts  to  purchase  and 
sale,  but  formal  interest  rarely  attaches  to  it.  We  are  un- 
accustomed to  consider  such  a  form  an  investment  where  there 
is  no  written  contract  and  transfers  of  the  credit  are  seldom 
made.  Since  1879  United  States  greenbacks  have  been  a  form  of 
public  credit  bearing  no  interest.     They  are  callable  credit  con 

38 


THE  CHANNELS  OF  INVESTMENT  39 

tracts.  Illustrations  might  be  multiplied.  It  is  the  purpose,  how- 
ever, merely  to  indicate  the  breadth  of  the  investment  field  and 
to  outline  its  main  channels. 

(b)  Loans  with  fixed  interest  are  those,  of  course,  with  which  we 
are  most  familiar,  and  require  no  comment  to  obtain  recognition. 

(c)  Loans  with  indeterminate  interest  rate  are,  fortunately,  in 
great  minority,  but  by  no  means  unknown.  Income  bonds  are 
typical  of  the  class. 

90.  Investments  Classified  by  the  Contract  of  Redemption.  A  more 
instructive  classification  of  pure  investments,  to  determine  the  place 
and  importance  of  bonds  among  them,  is  that  according  to  the  con- 
tract for  redemption.  Loans  may  be  payable  as  to  principal  (1)  at 
the  will  of  the  lender,  or  (2)  at  the  will  of  the  borrower,  or  (3)  at 
a  pre-arranged  time.  As  the  result  we  have  demand,  optional,  and 
_time  loans,  respectively.    Each  is  worth  comment. 

9L  Demand  Loans.  Since  the  one  essential  of  a  loan  is  its  ulti- 
mate return,  an  obligation  is  in  its  most  effective  state  when  the 
privilege  of  recall  may  be  exercised  by  the  lender  at  any  time. 
Measured  by  this  standard  demand  or  call  loans  are  the  purest  of 
simon-pure  investments.  Unfortunately  for  the  lender  (who  buys 
the  loan),  the  corresponding  right  to  make  payment  is  usually 
accorded  the  borrower.  If  there  is  more  than  a  possibility  that  this 
right  will  be  exercised  by  the  borrower  (who  sells  the  loan),  then 
the  investment  quality  called  "  duration,"  is  weakened. 

92.  Credit  balances  in  current  accounts,  which  have  just  been 
mentioned,  are  informal  demand  loans.  Greenbacks  are  really  de- 
mand loans,  by  virtue  of  their  formal  promise  of  payment ;  but  since 
they  bear  no  interest,  they,  too,  are  not  investment  instruments. 

93.  A  pass-book,  or  its  recent  substitutes,  is  a  certificate  of  a 
bank's  indebtedness  to  a  depositor,  and  if  interest  is  paid  on  the 
deposit,  represents  an  investment  of  the  demand-loan  type,  for, 
although  the  bank  may  have  the  right  to  close  the  account,  it  is 
usually  the  depositorjvho  recalls  the  loan. 

By  power  of  immediate  conversion  a  lender  can  protect  his  in- 
vestment against  depreciation  in  security,  and  against  reduction 
or  cessation  of  interest,  and  he  is  in  position  to  take  advantage  of 
low  prices  in  other  forms  of  security  investment.  This  last  is  no 
mean  advantage  if  he  is  competent  to  avail  himself  of  it,  for  interest 
on  demand  loans  is  highest  at  or  near  the  times  of  periodic  con- 
vulsions in  security  prices.  The  average  call-renewal  rate  in  New 
York  during  1907  was  about  6  2-5  per  cent.    The  chief  evil  that  con- 


40  THE  CHANNELS  OF  INVESTMENT 

version  cannot  directly  anticipate  is  the  decreasing  value  of  the 
monetary  units.  But  indirectly  conversion  may  forfend  loss  by 
transfer  of  funds  from  investment  to  deposit  or  speculative  account 
until  such  time  as  may  be  propitious  for  reinvestment.  But  he 
is  a  shrewd,  foreseeing  man  who  can  successfully  avail  himself  of 
this  possibility. 

94.  The  trouble  with  demand  loans  is  the  unreliability  of  this 
power  of  conversion,  when  it  is  most  desirable.  A  bank  account  is 
a  call  loan;  an  interest-bearing  bank  account  is  an  investment;  but 
if  the  majority  of  depositors  call  their  loans  in  concert,  the  bank 
must  close  its  doors.  The  majority  will  act  in  concert  only  at  the 
time  it  is  most  desirable  to  convert,  namely,  when  the  bank  is 
weakest,  whether  from  internal  or  general  financial  troubles. 
Against  concerted  action  the  laws  of  many  states  grant  savings 
banks  the  privilege  of  requiring  30  to  60  days'  notice ;  and  conversely, 
again,  this  privilege  is  naturally  exercised  at  the  very  time  that  it  is 
most  worth  while  to  investors  to  have  the  money  for  more  profitable 
use. 

95.  Call  loans  secured  by  highly  negotiable  collateral  (which  is 
the  basis  of  the  bulk  of  business  done  by  many  metropolitan  banks) 
is  a  better  type  of  investment,  technically,  than  bank  deposit,  but 
respecting  the  collateral  it  requires  a  superior  knowledge  of  in- 
trinsic values,  and  an  eternal  viligance  against  collapse  in  prices. 
Call  loans  in  financial  centers  were  by  no  means  as  good  as  cash 
in  the  fall  of  1907,  nor  were  deposits,  when  banks  and  trust  com- 
panies "  joined  together  in  repudiation  of  specie  payment." 

96.  The  ordinary  promissory  note  of  the  demand  type,  in  busi- 
ness, is  a  form  of  call  loan  which  is  losing  its  investment  standing, 
for  want  of  satisfactory  security.  It  is  probably  as  often  a  memo- 
randum of  obligation  as  a  genuine  loan.  Commercial  banks  will  take 
care  of  any  legitimate  extension  of  personal  credit,  and  there  is  no 
need  publicly  to  offer  personal  paper  that  is  callable. 

97.  Commercial  drafts  are  instruments  for  the  collection  of 
funds,  usually  on  demand;  but  when  drawn  they  are  not  credit 
instruments;  and  only  when  secured  by  indorsement  may  they  be 
used  as  credit  funds  and  pass  from  hand  to  hand.  But  as  such 
they  should  be  classified  as  demand  loans. 

Sometimes  overdue  notes,  and  often  matured  bonds,  remain  un- 
collected for  a  time.  If  payment  has  not  been  demanded  the  cause 
may  have  been  inertia  on  the  part  of  the  owner,  or  ignorance  or 
forgetfulness  of  the  due  date;  but  probably  more  often  than  not 


THE  CHANNELS  OF  INVESTMENT  41 

(particularly  in  the  case  of  government  bonds)  the  reason  is  that 
the  owner  is  more  concerned  in  having  a  safe  depository  for  his 
money,  than  in  getting  any  present  return  on  it.  Although  these 
overdue  loans  are  demand  loans,  they  are  not  investments  when 
they  make  no  return. 

98.  Optional  Loans.  The  adjective  "  optional,"  as  applied  to  loans, 
usually  has  reference  to  the  borrower:  it  is  optional  with  the  bor- 
rower to  return  the  funds.  We  have  noted  that  call  ?oans,  which  are 
demand  loans,  are  also  optional  loans.  That  is  to  say,  if  the 
privilege  of  recall  is  granted  the  lender  it  is  also  granted  the  bor- 
rower. Under  which  heading  a  call  loan  more  properly  falls,  de- 
pends upon  which  party  to  the  transaction  is  most  likely  to  exer- 
cise the  privilege  of  liquidation. 

99.  Bank  "  deposits,"  which  are  call  loans,  were  classified  as  de- 
mand loans  rather  than  as  optional  loans,  because  it  is  not  the 
policy  of  banks  to  retire  loans  or  borrowings.  In  the  case  of  de- 
posits, or  optional  loans  made  by  a  bank  to  others,  if  the  account 
is  undesirable,  the  bank  usually  insists  on  larger  equities  in  the 
collateral  or  on  higher  rates  of  interest.  Either  requirement  will 
eliminate  the  weaker  loans  or  strengthen  them. 

There  are  many  other  forms  of  optional  loans,  the  optional 
feature  usually  arising  from  the  peculiar  exigencies  of  the  bor- 
rower. Among  them  are  delinquent  tax  certificates,  and  city  and 
town  warrants.  Of  necessity  loans  returnable  at  the  will  of  the 
borrower,  the  obligor,  rather  than  at  the  will  of  the  lender,  the 
obligee,  as  a  class  are  an  inferior  form  of  investment. 

100.  There  is  no  conceivable  advantage  in  having  money  invested 
in  an  optional  loan,  merely  from  the  fact  that  the  loan  is  return- 
able at  any  time.  There  may,  however,  be  an  advantage  if  the  loan 
is  returnable  only  at  a  substantial  premium.  This  is  the  case  in 
bonds  which  are  callable,  let  us  say,  at  110.  The  buyer,  who  loans 
funds  to  the  issuing  corporation,  is  content  that  his  money  shall  be 
returned  to  him,  providing  that  he  shall  be  paid  a  bonus  of  10 
per  cent,  for  the  trouble,  and  possible  loss,  to  which  he  shall  be  put 
by  the  necessity  of  seeking  another  channel  of  investment  before 
the  regular  date  of  maturity. 

But  it  is  safe  to  say  that  when  an  investor  is  forced  to  part  with 
a  security  at  par,  which  otherwise  would  not  mature  for  some 
years,  it  is  to  his  disadvantage.  Naturally  the  security  would  not 
be  called  unless  it  was  good,  and  reinforced  by  equities  which  the 
issuing  company  wished  to  bond,  or  because  equities  or  current 


42  THE  CHANNELS  OF  INVESTMENT 

interest  rates  made  refunding  possible  at  a  lower  percentage  of 
interest.  In  most  cases  it  will  be  found  that  the  outstanding  issue 
is  an  encumbrance  and  that  the  option  clause  in  the  mortgage  has 
been  seized  upon  to  clear  away  the  old  issue  to  give  better  defined 
and  understood  security  to  the  new.  Very  few  owners  of  Seattle 
Lighting  Company  Debenture  Os,  we  venture  to  say,  were  pleased 
to  learn,  in  January,  1910  (with  investment  prices  at  a  fairly  high 
level),  that  their  6  per  cent,  investment,  which  cost  the  majority  of 
them  less  than  par,  and  therefore  netted  them  over  6  per  cent., 
was  to  be  retired  at  101,  to  better  the  position  of  the  refunding 
bonds. 

101.  But  even  at  a  considerable  premium,  the  callable  feature 
may  be  a  disadvantage  if  the  bond  would  sell  at  a  premium  without 
the  privilege  of  redemption.  An  illustration  is  the  Chicago  and 
Northwestern  Sinking  Fund  5s  and  6s  of  1929.  The  6s  are  now 
selling  at  a  price  to  net  somewhat  over  5  per  cent.  The  merits  of  an 
obligation  of  the  Chicago  and  Northwestern  of  this  grade  entitle 
it  to  sell  at  nearer  a  4  per  cent,  than  a  5  per  cent,  basis.  But  a  sum 
equal  to  at  least  1  per  cent,  of  the  outstanding  bonds  must  be  ap- 
propriated to  the  purchase  of  them  at  a  price  not  exceeding  105,  at 
which  they  may  be  drawn  by  lot  for  cancellation.  Therefore,  the 
purchaser  runs  the  risk  of  losing,  at  105,  a  G  per  cent,  bond  now 
selling  for  about  111. 

More  light  is  thrown  on  the  advantage  or  disadvantage  of  call- 
able bonds  by  the  comments  on  estimating  their  net  yields. 

102.  Perpetual  Loans.  There  are  certain  of  the  so-called  "  perpet- 
ual loans  "  that  are  really  hybrid,  and  properly  classified  under  op- 
tional loans.  They  have  no  date  of  maturity  and  may  not  be  re- 
deemed by  the  owners ;  but  the  issuing  government  or  corporation 
may  redeem  them  at  will  or  after  a  certain  time.  The  Republic  of 
Cuba  (External  Debt)  5s  represent  a  government  coupon  obliga- 
tion of  this  type,  callable  at  100,  and  the  Securities  Company,  of 
New  York,  4  per  cent.  Consols,  a  registered  corporation  bond,  call- 
able at  105.  The  privilege  of  redemption  at  105  of  a  4  per  cent. 
*'  perpetual  "  corporation  bond  is  hardly  an  objectionable  feature. 

103.  Perpetual  loans  (particularly  those  that  are  irredeemable) 
are  altogether  the  despair  of  any  who  try  to  think  logically.  They 
are  the  fourth  dimension  of  security  investment.  In  the  first  place 
a  loan  is  a  promise  to  pay,  and  an  investment  security  is  a  formal 
written  contract  for  the  future  delivery  of  specified  funds.  A  con- 
tract of  payment  implies  a  stipulated  time;  and  no  time  is  set  for 


THE  CHANNELS  OF  INVESTMENT  43 

the  repayment  of  perpetual  loans.     Therefore  they  are  not  con- 
tracts; therefore  they  are  not  loans. 

The  flaw  in  this  reductio  ad  absurdum  is  the  assumption  that 
the  return  upon  the  investment  is  necessarily  rental,  or  interest, 
and  nothing  more.  Since  perpetual  loans  are  bought  with  full 
knowledge  that  they  are  not  to  be  repaid,  and  that  conversion  may 
be  attained  only  by  sale,  as  in  speculations,  the  net  yield  on  the 
purchase  price  must  be  considered  as  composed  of  the  rental  value 
money  for  very  long  time  investments,  and  an  insurance  premium 
to  cover  the  risk  of  depreciation  in  the  security  for  a  "  loan " 
of  the  given  grade,  whether  it  be  the  good  faith  of  a  government  or 
the  tangible  properties  of  a  corporation. 

104.  To  estimate  the  amount,  per  annum,  of  insurance  premium, 
it  is  necessary  to  estimate  the  degree  of  risk.  The  better  the  se- 
curity for  the  investment,  the  less  the  premium.  But  in  consider- 
ing the  quality  of  the  security,  durableness  is  a  virtue  distinct  from 
equities.  The  perpetual  obligation  of  a  highly-prosperous  but 
tariff-dependent  industrial  corporation,  albeit  secured  by  properties 
worth  many  times  the  authorized  bond  issue,  would  be  considered  by 
the  discerning  as  inferior  to  the  simple  short  term  debenture  of  the 
better  American  municipalities. 

Considered  in  this  light,  perpetual  loans  do  not  offer  such  prom- 
ising material  for  mental  calisthenics.  The  "  loan,"  then,  is  repaid 
in  the  form  of  an  insurance  premium ;  but  how  soon  repaid  depends 
on  the  quality  of  the  security.  The  poorer  the  security  the  lower 
should  be  the  price,  in  order  that  the  net  return  may  be  sufficiently 
large  to  contain,  beside  the  rental  value  of  a  long  time  loan,  an 
insurance  premium  to  cover  the  value  of  the  principal  of  the  loan, 
in  a  greater  or  less  number  of  decades. 

If  the  perpetual  loan  remains  good,  and  pays  interest  after  the 
insurance  premiums  have,  in  a  sense,  retired  it,  there  has  been  an 
appreciation  in  the  investment. 

105.  The  longer  the  life  of  a  loan  the  less  valid  is  a  projection 
of  present  factors  of  safety  as  determining  the  future  safety.  That 
is  why  a  short  term  unsecured  note  of  company  with  steady  earn- 
ings, largely  in  excess  of  fixed  charges,  may  be  safer  than  its  first 
mortgage  long  term  bonds.  The  application  of  this  principle  ad 
infinitum  to  perpetual  loans  is  a  cause  of  their  gradual  decline  in 
popularity.  The  nations  of  Europe,  which  formerly  issued  these 
interminable  obligations,  are  gradually  adopting  our  policy  of  pay- 
ing a  debt  within  two  decades. 


44  THE  CHANNELS  OF  INVESTMENT 

106.  As  far  as  security  is  concerned,  a  bond  which  runs  for  sev- 
eral centuries  is  practically  a  perpetual  loan.  The  maturity  date 
of  the  West  Shore  Railroad  First  4s,  which  is  Jan.  1,  2361,  is  hardly 
of  security  value  to  the  present  generation.  The  character  of  the 
issuing  company,  and  of  the  lien,  and  the  guaranty  of  the  New 
York  Central,  are  factors  making  for  stability  in  the  market 
price  for  the  bonds.  It  is  in  the  ability  to  convert  this  bond 
in  the  open  market  that  the  investment  principle  of  repayment 
resides. 

107.  Time  Loans.  Time  loans,  in  the  parlance  of  the  Street,  are 
those  in  which  the  contract  sets  a  definite  time  for  the  future  de- 
livery of  funds,  and  in  which  there  exists  no  option  of  prior  payment 
for  either  party.  Of  course  by  (mutual)  consent,  the  loan  may  be 
paid  before  the  due  date;  but  this  de  lure  is  a  new  contract,  making 
void  the  old.  In  bonds  the  situation  is  illustrated  in  the  case  of  an 
issue  which  is  not  redeemable,  but  for  which  there  is  a  sinking  fund 
applicable  to  the  purchase  of  the  bonds,  in  whole  or  part,  in  the 
open  market.  Redeemable  bonds  are  time  loans  until  their  optional 
date.  If  callable  any  time  thereafter,  they  become  optional  loans. 
(See  §341.) 

108.  Time  loans,  of  course,  form  the  bulk  of  transactions  in  credit. 
The  fact  of  a  predetermined  maturity  date,  especially  in  credits  of 
short  tenure,  tends  to  check  fluctuations  in  investment  value.  The 
business  structure  would  shake  to  its  foundations  if  the  duration 
of  the  major  part  of  its  loans  was  uncertain. 

109.  For  an  enumeration  of  investment  channels  nothing  is  gained 
by  the  subdivision  of  time  loans  on  the  basis  of  duration  or  any 
other;  promissory  notes,  commercial  paper,  in  general  corporation 
notes,  revenue  loans,  etc.,  are  the  leading  channels  of  short  term  in- 
vestment; and  of  these  commercial  paper  is  by  far  the  most  im- 
portant. Even  in  this  country  with  its  bond-secured  currency 
there  is  a  growing  realization  that  with  better  facilities  for  the 
conversion  of  commercial  paper,  its  short  duration  would  permit 
the  maintenance  of  a  small  cash  reserve  to  the  benefit  of  business 
generally. 

National  banks,  commission  houses,  and,  in  general,  private  in- 
vestors who  have  occasion  or  are  accustomed  to  deal  in  bonds, 
rather  than  in  any  form  of  personal  or  industrial  paper,  may  quite 
readily  find  among  the  great  multitude  of  municipal  and  corpora- 
tion bonds  outstanding  some  issue  in  the  market  which  will  meet 
their  most  exacting  wants  respecting  month  of  maturity,  interest 


THE  CHANNELS  OF  INVESTMENT  45 

rate,  etc. ;  but  in  ordinary  times  these  short  term  loans  will  make 
a  small  return  upon  the  investment. 

For  the  general  purposes  of  investment,  loans  of  at  least  some 
years'  duration  serve  best.  Bonds  and  mortgages  are  the  two  stand- 
ard classes  of  loans  of  duration. 

110.  There  is  justification,  in  theory,  for  classifying  some  forms 
of  insurance  as  investments, — such  a  form  for  instance  as  endow- 
ment insurance  in  which  the  principal  with  interest  is  returned  at 
some  future  time.  These  forms  are  virtually  loans  in  the  nature  of 
contracts  to  deliver,  for  consideration,  certain  funds  under  certain 
conditions.  Their  security  ranks  very  high.  Some  forms  are  con- 
vertible, i.e.  have  a  "  cash  surrender  value "  and  have  excellent 
hypothecary  value.  But  insurance  policies  fail  as  investments, 
because  such  income  as  may  be  attached  to  them  is  small  and  in- 
cidental. The  placement  of  funds  in  insurance  has  protection,  not 
income,  as  the  primary  motive.  The  return  yielded  even  by  annui- 
ties proves  this. 

The  two  leading  investment  channels,  the  bond  and  the  mortgage, 
are  worth  a  careful  comparison,  such  as  we  essay  in  the  next 
chapter, — not  with  the  thought  of  extolling  one  at  the  expense  of 
the  other,  but  rather  for  the  sake  of  employing  the  investment 
tests  we  have  set  up,  and  to  come  to  a  satisfactory  understanding 
of  both  classes  of  investment. 

111.  However,  this  much  should  first  be  said,  that  a  cursory 
glance  over  the  loan  field  reveals  the  domination  of  bonds  and 
mortgages  among  the  various  kinds  of  investment.  Bonds  indeed 
are  closely  associated  with  mortgages.  Mortgage  bonds,  which  form 
the  bulk  of  our  corporation  funded  issues,  are  merely  fractional 
parts  of  ownership  in  a  mortgage.  There  is  very  little  difference, 
again,  between  a  bond  and  a  promissory  note.  The  bond  is  usually 
one  of  a  series  and,  by  common  law,  more  necessarily  formal  in  its 
make-up.  Promissory  notes,  in  turn,  are  a  form  of  commercial 
paper,  and  so  also  are  drafts.  A  survey  of  the  channels  of  invest- 
ment, then,  leads  to  the  conclusion  that  bonds  and  mortgages  domi- 
nate all  other  classes  of  pure  investment. 


CHAPTER  VI 
BONDS  VERSUS  MORTGAGES 

112.  In  the  financial  forum  no  topic  furnishes  material  of  livelier 
interest  for  debate  than  the  time-honored  question :  "  Which  are  the 
better  investment,  bonds  or  mortgages?  "  The  contest  is  fought  over 
and  over  again  without  casualties  to  either  side,  and  each  time, 
when  Ihe  tumult  and  the  shouting  dies,  advantage  never  seems  to  rest 
convincingly  with  either  side.  An  attempt  will  be  made  in  this 
discussion  to  avoid  the  usual  parti  pris  if  even  at  the  expense  of 
the  interest  engendered  by  partizanship.  There  can,  however,  be 
no  question  that,  between  them,  bonds  and  mortgages  nearly 
monopolize  the  disposition  of  funds  destined  by  private  persons  for 
permanent  investment,  if  one  disregards  savings  bank  deposits. 
Bonds  and  mortgages  are  the  principal  channels  of  investment. 
This  being  the  case,  it  is  not  a  matter  of  surprise  that  the  discussion 
of  their  respective  merits  should  recur  perennially. 

Perhaps  a  satisfactory  way  to  present  the  pros  and  cons  is  to 
apply  the  requirements  of  our  ideal  investment.  In  the  following 
comparisons  it  is  most  necessary  to  remember  that  we  are  dealing 
with  bonds  as  a  class  and  mortgages  as  a  class,  and  that  each  class 
has  within  it  loans  good,  bad,  and  indifferent.  Comparison  remains 
fair  and  profitable  only  by  steadfastly  adhering  to  the  types. 

113.  Security  of  Principal.  It  is  unfortunate  that  no  reliance  can 
be  placed  upon  statistical  material  in  considering  the  relative  se- 
curity of  funds  invested  in  bonds  and  mortgages.  Only  by  visiting 
every  office  of  record  could  one  ascertain  the  number  and  value  of 
mortgages  that  go  wrong  from  year  to  year.  A  census  of  bond  de- 
faults would  be  an  equally  herculean  labor.  It  is  not,  however,  be- 
yond possibility  that  municipal  defaults,  and  the  causes  therefor, 
will  be  accurately  recorded  in  the  future.  Henceforth  all  neces- 
sary facts  for  the  appraisement  of  railroad  bonds  may  be  had  from 
the  Interstate  Commerce  Commission.  Private  enterprise  may,  in 
time,  collate  data  already  extant,  relating  to  failures  of  public 
service  corporations.  Indeed  beginnings  have  already  been  made 
by  the  bond  houses;  but  their  investigations  are  for  business  pur- 

46 


BONDS  VERSUS  MORTGAGES  47 

poses  and  not  universally  for  publication.  The  obligations  of  indus- 
trial corporations  will  give  meager  statistical  returns  for  years  to 
come. 

114.  Statistics  aside — no  one  conversant  with  bonds  and  mort- 
gages will  deny  that  American  municipal  bonds  have  been,  for  the 
last  20  years,  a  safer  investment  than  American  real  estate  mort- 
gages; or  that  American  "industrial,  mining,  and  miscellaneous" 
bonds, — if  they  may  so  be  classed, — are  more  unsafe  than  real 
estate  mortgages.  The  debatable  ground  respects  the  relative  se- 
curity of  railroad  and  public  service  bonds  and  real  estate  mort- 
gages; and  therefore  of  bonds  as  a  class,  and  real  estate  mortgages. 

115.  Overlooking  the  broader  comparison,  attempts  have  been 
made  to  draw  conclusions  particularly  from  railroad  bonds  and  real 
estate  mortgages  because  both  are,  in  the  main,  directly  secured  by 
material  property.  The  line  of  attack  by  the  partizan  of  bonds  is 
this:  About  50  per  cent,  (let  us  say)  of  railroad  capitalization  in 
the  United  States  is  in  bonds.1  The  other  50  per  cent.,  which  is 
stock  capitalization,  is  an  equity  upon  the  face  of  which  about  6 
per  cent,  is  being  earned.  Assuming  that  stock  should  earn  10  per 
cent,  upon  its  market  value,  the  stock  equity  is  worth  over  50  per 
cent,  of  the  face  value  of  the  bonds.  Putting  the  fact  conversely, 
American  railroads  are  bonded  for  less  than  two-thirds  of  their 
value. 


116.  This  statement  of  railway  capitalization  is  unquestionably 
conservative,  and  the  argument  well  enough  as  far  as  it  goes;  but 
of  course  we  have  no  figures  to  prove  that  mortgaged  real  estate, 
the  country  over,  has  or  has  not  a  clear  equity  of  one-third.  One 
might  find  the  amount  of  real-estate  mortgages  recorded  within  a 
municipal  district  and  lay  it  over  against  the  assessed  valuation  of 
the  real  property  in  that  district  and  come  to  some  valid  conclu- 
sion as  to  the  equity  in  that  district ;  but  until  the  time  that  all  real 
property  in  the  United  States  is  assessed  at  actual  value,  and 
until  the  census  special  reports  give  us  the  total  amount  of  recorded 
mortgages,  one  man's  guess  is  as  good  as  another's  regarding  aver- 
age equity  for  these  mortgages. 

117.  As  a  matter  oLsquitifia,  then,  the  comparison  elicits  small 
satisfaction.  The  stability  of  these  equities  is  next  in  question;  and 
again  trustworthy  figures  are  wanting.  If  an  expression  of  opinion 
is  acceptable,  the  writer  believes  that  in  this  respect  there  is  little 

1  The  ratio  of  funded  debt  to  total  capitalization  is  considerably  in  excess 
of  50  per  cent. 


48  BONDS  VERSUS  MORTGAGES 

to  choose  between  realty  values  and  corporate  property  values  as  a 
whole.  But  a  decided  exception  must  be  taken  in  regard  to  rail- 
road and  industrial  equities, — to  railroad  because  the  extreme  mar- 
ketability of  railroad  stocks  makes  them  susceptible  to  more  acute 
variations  in  market  value;  and  to  industrial  because  the  nature  of 
industrial  business  implies  extreme  fluctuations  in  earnings.  On 
the  other  hand,  the  equity  in  municipal  bonds  is  so  tremendous 
(usually  from  90  to  95  per  cent,  if  we  may  speak  of  the  equity  as  the 
difference  between  the  net  debt  and  the  real  or  even  the  assessed 
valuation)  that  the  stability  of  this  equity  is  of  the  highest. 

118.  Since  the  equities  in  railroad  and  industrial  bonds  are  dis- 
tinctly variable, — these  securities  require  a  greater  "  margin  of 
safety "  than  mortgages  or  than  most  other  bonds.  Some  time 
ago  St.  Louis  and  San  Francisco  General  (now  First)  5s,  Wheel- 
ing and  Lake  Erie  First  5s,  St.  Louis,  Iron  Mountain,  and 
Southern  General  Consolidated,  and  Land  Grant  5s,  and  Minne- 
apolis and  St.  Louis  First  Consolidated  5s,  were  advertised  as  sell- 
ing on  a  5  per  cent,  basis,  with  equities  of  from  200  to  1000  per  cent., 
estimated  by  the  market  value  of  the  junior  securities.  At  that 
time  good  Eastern  real  estate  mortgages  were  paying  5  per  cent, 
and  the  equity  at  going  prices  may  have  been  40  per  cent.  These 
facts  were  stated  in  a  circular  bond  offering,  and  put  these  railroad 
bonds  in  a  strikingly  favorable  light.  The  comparison  was  not  just, 
however,  for  no  allowance  was  made  for  the  greater  stability  of 
Eastern  realty  values. 

119.  Perhaps  it  was  about  this  time  that  an  industrial  bond  gave 
an  excellent  illustration  of  the  importance  of  stability  in  equities. 
Columbus  and  Hocking  Coal  and  Iron  First  5s  were  quoted  at  91, 
bid  in  January,  1910,  just  before  the  collapse  of  the  Keene  pool  in 
the  common  stock ;  but  immediately  afterward  they  could  be  bought 
anywhere  from  25  to  40.  There  had  been  no  ebange  in  the  material 
properties  of  the  Columbus  and  Hocking  Company.  The  equity  in 
stock  value  had  merely  collapsed, — in  this  case  because  artificially 
inflated. 

After  all  has  been  said,  probably  the  equities  in  public  corpora- 
tions are  generally  underestimated,  for  it  is  easier  to  remember  that 
new  enterprises  are  "  built  on  bonds "  than  it  is  to  realize  the 
amount  of  surplus  earnings  that  have  been  put  back  into  the  prop- 
erties, or  to  recall  the  amount  of  subsequent  issues  of  stock  and 
junior  liens,  the  proceeds  from  which  improve  and  enlarge  the  plant 
and  equipment. 


BONDS  VERSUS  MORTGAGES  49 

120.  The  Hocking  Coal  and  Iron  incidents  are  by  no  means  con- 
fined to  bonds.  Mortgages  have  their  striking  vicissitudes  showing 
the  mutable  nature  of  equities.  A  7  per  cent,  first  mortgage  on 
central  business  property  at  GO  per  cent,  of  the  assessed  value  was 
no  uncommon  thing  in  Seattle  or  Tacoma  in  1890.  By  Eastern 
standards  such  a  mortgage  was  a  good  investment,  and  the  return 
was  no  more  than  capital  in  the  West  at  the  time  demanded.  But 
in  1895  that  margin  of  safety  was  wiped  out,  and  many  an  East- 
ern investor  found  himself  in  possession  of  unproductive  Tacoma 
real  estate.  Yet  the  same  sort  of  mortgages  (with  lower  interest 
rate  of  course),  placed  in  New  York  or  Philadelphia,  would  have 
remained  intact  and  the  margin  of  safety  would  not  have  been  even 
threatened. 

121.  Security  as  Affected  by  Guaranty.  The  guaranty  is  a  much 
more  dependable  source  of  security  to  mortgages  than  to  bonds. 
Although  there  are  many  exceptions,  particularly  among  divisional 
railroad  issues,  the  fact  of  bond  guaranty  is  in  itself  an  inference  of 
inferior  security.  The  guaranty  for  mortgages  as  given  by  a  mort- 
gage guaranty  company,  however,  is  more  truly  an  insurance  against 
individual  misjudgment  of  investment  or  individual  property  hazard, 
by  distribution  of  the  risk  among  many  investors,  and  has  no  natural 
implication  of  intrinsic  inferiority  in  the  mortgage  guaranteed.  Of 
the  hundreds  of  millions  of  dollars  in  mortgages  thus  insured  by 
the  New  York  mortgage  companies,  there  has  been  very  little  mone- 
tary loss  to  the  companies,  and  probably  none,  as  yet,  by  investors. 

122.  But  guaranteed  mortgages  are  too  recent  to  have  proved 
their  worth  under  all  possible  conditions.  The  guaranty  might 
prove  of  little  value  as  insurance  against  a  widespread  calamity, 
such  as  a  long  and  extreme  financial  depression,  or  a  flood,  or  con- 
flagration— against  anything,  in  fact,  that  could  wipe  out  real  es- 
tate equities  generally  in  the  territory  in  which  the  guaranty  com- 
pany operates.  In  crises  of  this  kind  the  capital  and  surplus  of  the 
guaranty  companies  might  be  no  more  than  a  drop  in  the  bucket, 
since  their  contingent  liabilities  very  greatly  exceed  their  free 
assets. 

123.  Unfortunately,  more  often  than  not  it  will  be  found  that 
this  capital  and  surplus  are  invested  in  the  very  class  of  properties 
and  mortgages,  and  in  the  very  localities  that  have  obtained  the 
mortgage  companies'  guaranties.  If  this  were  not  the  case,  but  if 
these  funds  were  widely  distributed  in  marketable  obligations  such 
as  bonds  and  other  securities  that  are  legal  for  insurance  company 


50  BONDS  VERSUS  MORTGAGES 

investment,  the  guaranty  would  be  worth  more  if  ever  put  to  the 
test  of  some  extraordinary  catastrophe.  As  conditions  now  are,  it 
has  been  estimated  that  under  such  a  stress  the  value  of  the  guar- 
anty would  be  worth  about  5  per  cent,  of  the  face  of  the  mortgages. 
"  On  a  piece  of  property  worth  $100,000  upon  which  a  guaranteed 
mortgage  of  $00,000  exists,  the  guaranty  would  be  worth  $3,000,  and 
would  margin  the  property  down  to  $57,000." 

124.  There  is  quite  another  point  of  view  from  which  investment 
security  may  be  conceived.  Assuming  that  there  is  no  choice  between 
bonds  and  mortgages  per  sc  as  safe  channels  of  investment,  the 
possible  long  duration  of  bonds  can  protect  women  and  minors,  and 
all  legatees  under  wills  from  the  spoliation  of  funds  left  in 
trust.  Perhaps  more  money  is  lost  to  beneficiaries  through  un- 
just fees,  and  the  like,  than  by  unwise  investment.  It  is  not 
possible  to  protect  trust  funds  from  fees  and  commissions  that 
are  little  short  of  robbery,  if  the  funds  are  placed  in  channels 
that  make  reinvestment  necessary  once  in  three  or  five  years.  Of 
all  the  uses  to  which  bonds  lend  themselves,  this  is  most  distin- 
guished and  satisfying:  of  permitting  the  disposal  of  trust  funds 
over  a  long  period  of  years,  where  the  funds  cannot  be  converted 
at  any  one's  pleasure  and  cannot  even  be  tampered  with. 

Fees  and  other  costs  attendant  upon  the  foreclosures  of  a  real 
estate  mortgage,  eat  more  deeply  into  the  principal  than  the  same 
charges  that  are  likely  to  be  pro  rated  among  the  depositors  of 
defaulted  bonds  by  a  bondholders'  protective  committee,  on  the 
principle  that  the  larger  the  undertaking,  the  less  the  unit  of 
cost. 

125.  Security  of  Interest.  When  we  were  canvassing  the  ele- 
ments of  a  perfect  investment,  we  laid  stress  on  the  thought  that 
there  was  no  necessary  direct  relation  between  security  of  princi- 
pal and  security  of  interest.  Although  it  is  true,  broadly  speak- 
ing, that,  within  a  given  class  of  loans,  the  stronger  the  security 
the  more  certain  the  interest  payment  during  the  life  of  the  loan, 
nevertheless,  as  between  classes,  a  much  inferior  grade  of  security 
as  respects  the  principal  may  present  a  much  superior  grade  of  in- 
terest. The  point  has  its  most  apt  illustration  in  the  relative  se- 
curity for  bond  interest  and  mortgage  interest. 

126.  In  our  conception  of  what  constitutes  security  of  interest 
it  is  not  necessary,  nor  indeed  advisable,  to  confine  ourselves  to  the 
mere  duration  of  the  loan  instrument.  Necessity  of  frequent  rein- 
vestment may  be  considered  in  its  relation  to  interest.     To  satisfy 


BONDS  VERSUS  MORTGAGES  51 

ourselves  on  this  point  let  us  submit  to  analysis  this  investment 
element  called  Security  of  Interest. 

127.  If  we  loan  money,  over  a  period  of  years,  we  expect  a  rental, 
called  interest,  for  its  use.  We  desire,  first  of  all,  to  be  sure  of 
getting  it;  secondly,  to  get  it  at  certain  regular  intervals;  and, 
thirdly,  to  get  at  least  as  much  in  the  future  as  at  present.  If  we 
are  not  afraid  of  being  academic  we  can  classify  these  qualities  of 
the  interest  charge  as  (1)  Certainty  of  payment:  (2)  Regularity  of] 
payment;  and   (3)   Perpetuity  of  rate.  1 

128.  In  respect  to  (1)  Certainty  of  payment  (certainty  being 
used  in  a  comparative  sense),  bonds  and  mortgages  are  most  nearly 
on  equal  terms.  This  is  because  forfeiture  of  property  is  the  penalty 
for  non-payment  of  interest  on  mortgages  and  corporation  bonds. 
Although  there  is  no  property  security  for  the  great  majority  of 
civil  loans,  and  the  principal  does  not  mature  on  default  of  the 
interest  still  the  high  standing  of  civil  credit,  from  the  federal  gov- 
ernment to  the  assessment  district,  prevents  unsecured  civil  obli- 
gations from  lowering  the  Certainty  of  Interest  maintained  by 
bonds  as  a  class. 

If  interest  defaults  on  any  collateral  obligation  it  is  recoverable 
at  law  out  of  the  collateral.  It  follows,  therefore,  as  a  corollary 
to  the  equally  good  security  for  the  principal  of  bonds  and 
mortgages,  that  there  is  equal  certainty  of  ultimate  interest 
payment. 

129.  (2)  Regularity  of  payment  is  quite  another  matter,  and 
hardly  less  important,  considering  the  uses  to  which  investments 
are  put.  The  payment  of  interest  on  corporate  obligations  is  a 
matter  of  routine  business  and  is  in  preparation,  by  the  very  method 
of  keeping  accounts,  from  the  day  that  interest  begins  to  accrue. 
The  prompt  payment  of  interest  on  real  estate  mortgages,  which 
generally  represent  personal  obligations,  is  dependent  on  life,  health, 
and  even  memory.  If  payment  of  mortgage  interest  is  not  delayed 
by  some  accident  of  nature,  the  chances  are  much  greater  that  a 
temporary  embarrassment  will  suspend  payment  by  an  individual 
than  by  a  corporation.  Surpluses  invested  in  quick  assets,  and 
systematic  cash  reserves,  are  protections  of  corporate  accounting 
rarely  employed  by  an  individual.  When,  in  a  business  crisis,  a 
railroad  or  a  public  service  corporation  has  to  suspend  dividends,  or 
even  to  pay  them  in  scrip,  for  want  of  ready  cash,  it  is  a  matter 
of  public  comment. 

Sometimes  a  corporation  is  obliged  to  default  interest  on  its 


52  BONDS  VERSUS  MORTGAGES 

bonds  for  a  time,  although  fundamental  conditions  warrant  belief 
that  a  resumption  can  be  made  in  the  future.  If  its  obligations  were 
floated  by  a  bond  house  of  standing,  the  house  might,  and  very 
frequently  does,  advance  the  interest  to  those  who  bought  the 
bonds  of  it.  For  the  possibility  of  this  protection  of  interest  pay- 
ments, if  for  no  other,  it  is  highly  desirable  that  investors  should 
deal  with  responsible  principals,  not  with  brokers,  when  purchas- 
ing bonds.  There  is  no  similar  sponsor  for  the  payment  of  un- 
guaranteed mortgage  interest. 

130.  (3)  Perpetuity  of  the  interest  rate  is  a  phase  of  interest 
that  receives  much  less  attention  than  it  merits.  We  have  said 
that,  in  our  conception  of  what  constitutes  security  of  interest,  it 
is  not  necessary,  nor  indeed  advisable,  to  confine  ourselves  to  the 
mere  duration  of  the  loan  instrument.  Credits,  in  the  commercial 
world,  are  seldom  really  amortized ;  they  are  extended  at  maturity, 
or  converted  into  other  forms  more  suitable  to  changed  conditions. 
Most  short  term  loans  are  contracted  by  both  parties  with  the 
purpose  of  refunding  at  expiration,  either  with  each  other  or  with 
third  parties.  In  this  continuous  metabolism  of  credits,  security 
of  interest  has  to  suffer,  especially  as  regards  perpetuation  of  the 
rate.  In  a  true  sense  then,  quite  apart  from  the  security  of  the 
respective  principals,  a  five-year  railroad  note  offers  more  security 
of  interest  than  a  three-year  note.  Extending  this  principle  to  bonds 
and  real  estate  mortgages  as  classes  of  investments,  bonds  can 
assure  the  lender  a  more  uniform  rate  because  of  a  longer  possible 
duration. 

131.  In  summary,  although  the  "  certainty "  of  recovering  de- 
faulted income  is  about  equal  as  between  bonds  and  mortgages, 
security  of  interest,  as  a  whole,  is  greater  in  bonds  because  there 
is  greater  likelihood  of  regularity  in  payment  and  less  likelihood 
of  change  in  the  rate  on  refunding. 

132.  The  guaranty  of  established  and  conservative  mortgage 
trust  companies  is  a  very  great  assurance  that  mortgage  interest 
will  be  paid  promptly.  In  fact,  it  is  the  policy  of  these  companies 
to  contract  to  pay  interest  on  the  due  date,  with  their  own  checks, 
irrespective  of  whether  they  have  been  paid  by  the  mortgagor,  or 
not.  Guaranteed  mortgages  therefore  have  but  one  element  of  weak- 
ness in  security  of  interest : — that  resulting  from  change  in  interest 
rates  due  to  comparatively  frequent  reinvestment. 

133.  Fair  Income  Return.  It  is  generally  conceded,  even  by  those 
who  are  interested  in  making  out  the  best  case  possible  for  bonds, 


BONDS  VERSUS  MORTGAGES  53 

that  mortgages  make  the  better  return.    People  who  stop  to  think  \ 
do  not  mean  by  this  that  the  average  interest  rate  on  mortgage 
paper  exceeds  the  average  interest  rate  on  bonds;  but  rather,  that 
with  the  same  degree  of  security  for  the  invested  principal,  mort- 
gages yield  the  larger  return. 

134.  Waiving  this  important  point  for  the  moment,  the  writer 
raises  a  question  equally  important  but  generally  overlooked :  sup- 
pose that  a  bond  and  a  mortgage  each  possess  the  same  degree  of 
excellence  in  all  other  investment  elements;  which  will  yield  the 
most?     The  bond,  unquestionably. 

To  answer  the  question  thus  categorically  is  to  anticipate  com- 
parisons yet  to  come. 

135.  To  return  to  the  matter  of  yield,  relative  to  security. 
The  rate  for  gilt-edge  real  estate  loans  varies  of  course  with  time 
and  place.  Sound  large  loans  on  central  business  property  in 
New  York  have  been  made  at  3  per  cent,  when  money  was  cheap. 
Such  loans  at  most  favorable  times  do  not  bring  over  4-|  per  cent. 
The  security  for  these  loans  is  about  on  a  par  with  that  of  the 
better  municipal  bonds,  which  have  about  the  same  range  of 
yield.  Mortgage  loans  never  average  higher  than  5  per  cent,  in 
the  East  or  6|  per  cent,  in  the  West  and  South. 

136.  The  return  from  mortgages,  however,  is  reduced  by  certain 
costs,  the  extent  of  which  will  vary  according  to  the  amount  of 
attention  to  the  investment  that  the  lender  is  able  and  willing  to 
give.  He  may,  to  be  sure,  act  for  himself.  He  may  be  capable  of 
searching  the  county  records  to  see  that  the  abstract  of  title  has 
been  properly  drawn,  and  that  the  borrower  is  the  actual  owner  of 
the  property  and  that  the  borrower  is  legally  competent  to  execute 
a  valid  mortgage,  and  that  the  instrument  is  binding  and  the  lien 
of  the  character  described.  He  may  be  competent  to  appraise  the 
property,  both  as  to  present  and  future  value,  and  to  look  after 
taxes,  assessments,  and  insurance.  But,  to  make  fair  the  compari- 
son with  bonds,  the  lender  must  be  presumed  to  delegate  to  agents 
all  attention  to  investment  details,  since  the  trustee  for  the  bonds 
and  the  vending  bond  house  exercise  all  supervising  functions  over 
the  bond  investment.  The  chapter  on  Tlie  Bond  Houses  will  develop 
this  thought  more  completely. 

137.  For  guaranteed  mortgages  the  guaranty  company  exercises 
the  sort  of  supervision  referred  to,  and  its  usual  charge  for  the  serv- 
ices rendered  is  £  of  1  per  cent,  of  the  income.  This  is  the  price 
of  the  insurance,  and  for  that  freedom  from  care  which  is  a  great 


54  BONDS  VERSUS  MORTGAGES 

virtue  of  bond  investment.  But  it  is  a  high  price  to  pay.  It  re- 
duces the  return  of  a  5  per  cent,  mortgage  to  44  per  cent. 

138.  If  one  glances  at  the  quotation  sheets  of  the  New  York 
Stock  Exchange  he  will  find  even  among  the  quickly  convertible 
railroad  bonds  many  issues  of  very  high  grade,  such  as  can  cOn- 
sc  ientiously  be  recommended  to  persons  dependent  upon  the  in- 
come, that  will  net,  in  normal  times,  from  about  4.40  to  more  than 
4f  per  cent.:  such  great  issues  as  the  Baltimore  and  Ohio  (Pitts- 
burg, Lake  Erie,  and  West  Virginia)  4s,  the  Rio  Grande  Western 
First  4s,  the  St.  Louis,  Iron  Mountain  and  Southern  (River  and 
Gulf  Division)  First  4s,  and  the  Oregon  Short  Line  Refunding  4s.1 

Numerous  large  issues  of  generally  known,  but  less  active  bonds,  both 
listed  and  unlisted,  might  be  mentioned,  which  have  security  at 
least  equal  to  that  for  the  above  bonds,  but  which  are  not  of  the 
railroad  class,  and  therefore  do  not  enjoy  a  correspondingly  wide 
repute  and  confidence,  and  consequently  are  not  subject  to  such  com- 
petitive demand.  These  may  generally  be  had  at  a  price  to  net 
from  about  4f  to  5  per  cent.  Among  them  are  the  Milwaukee  Gas 
Light  and  Power  Co.  First  4s,  the  Union  Electric  Light  and  Power 
Co.  (St.  Louis)  First  5s,  issues  of  equipment  bonds  on  the  standard 
railways,  and  many  underlying  mortgage  obligations  of  various 
corporations. 

139.  There  is  still  a  third  class  of  bonds,  great  in  numbers,  but 
smaller  in  size  of  issue,  and  of  much  narrower  and  less  responsive 
market,  which  rank  in  security  with  those  of  the  other  two  classes, 
but  which  may  be  bought  at  a  price  to  net  from  5  to  G  per  cent, 
and  even  more,  for  they  are  harder  to  sell,  both  at  the  time  of  flota- 
tion and  afterward,  since  they  require  detailed  investigation  like 
good  mortgages  of  the  same  yield. 

140.  In  view,  therefore,  of  the  necessary  miscellaneous  costs 
attending  safe  mortgage  investment,  or  of  the  equivalent  cost  of  in- 
surance and  delegated  supervision  by  guaranty  companies,  which  re- 
duces the  average  net  return  to  4£  per  cent,  or  less,  the  writer  is  un- 
convinced that  mortgages  net  more  upon  the  investment  than  bonds 
of  equal  security,  irrespective  of  any  other  elements  of  investment 
superiority  that  bonds  may  possess. 

141.  The  shorter  duration  of  mortgage  loans  was  seen  to  have 


1  For  many  years  the  average  rate  of  coupon  interest  paid  on  American  railroad 
obligations  has  boon  about  4|f  per  cent.,  but  the  average  net  return  is  much 
greater,  because  there  is  a  better  market  for  discount  than  for  premium  bonds. 


BONDS  VERSUS  MORTGAGES  55 

a  possibly  unfavorable  effect  upon  the  security  of  both  principal 
and  interest,  (§130)  and  it  may  likewise  lessen  the  net  return, 
providing,  as  before,  we  desire  a  continuous  investment  and  have 
our  thoughts  upon  that  rather  than  upon  the  particular  mortgage 
instrument.  Upon  the  expiration  of  a  mortgage  loan  it  may  not  be 
possible  for  the  lender  to  renew  the  mortgage  on  as  favorable  terms, 
if  at  all,  so  that  he  must  seek  another  mortgage.  When  found, 
title-search  and  "  the  law's  delay  "  mean  a  further  loss  of  a  month's 
interest  to  detract  from  the  net  return. 

The  effect  of  taxation  on  net  return  is  a  topic  for  separate  treat- 
ment. 

142.  Marketability.  As  relating  to  this  comparison  the  other  in- 
vestment elements  may  be  dealt  with  more  summarily.  Bonds  are 
the  most  merchantable  of  all  long  term  investment  or  speculative 
securities,  because  they  combine  the  virtues  of  negotiable  instru- 
ments with  the  investment  virtues.  Broadly  speaking,  mortgages 
are  unmarketable,  except  by  chance,  because  they  are  not  negotiable 
instruments,  and  have  as  security  property  units  so  different  from 
one  another  as  not  to  admit  of  classification  and  appraisal.  The 
scale  of  bond  issues,  implying  scattered  and  diversified  ownership, 
creates  competitive  investment  demand.  There  is  an  investment 
demand  for  mortgages  as  such,  but  respecting  a  single  mortgage, 
no  competitive  demand.  For  this  reason  National  banks,  which 
are  obliged  to  maintain  liquid  reserves,  are  forbidden  by  law  to 
invest  in  mortgages.  On  the  other  hand,  a  large  part  of  the  reserves 
of  Eastern  banks  is  kept  in  bonds.  Savings  banks,  which  are  not 
under  the  same  necessity  to  meet  demands  requiring  sudden  liquida- 
tion of  their  assets,  invest  in  both  bonds  and  mortgages. 

The  briefer  average  duration  of  mortgages  is  a  partial  offset  to 
their  lack  of  marketability ;  but  short  term  notes  and  early-maturing 
bonds  are  as  convertible  as  the  longer  bond  issues,  and  sometimes 
more  convertible. 

143.  Hypothecary  Value.  Always  closely  associated  with  the 
quality  of  convertibility  is  the  possibility  of  hypothecating  the  in- 
vestment. This  is  because  quick  convertibility  implies  a  consensus 
of  opinion  as  to  market  price,  and  therefore  a  common  knowledge 
of  the  equity  over  and  above  the  temporary  loan  requested.  Need- 
less to  say  that  it  is  comparatively  difficult  to  borrow  on  a  mort- 
gage. Many  a  business  man,  who  has  dealt  in  real  estate  for  years, 
does  not  know  whether  his  bank  would,  or  could  loan  in  this  way. 
The  hypothecation  of  first  mortgages  is  possible,  even  by  savings 


56  BONDS  VERSUS  MORTGAGES 

banks  in  some  states,1  but  it  is  generally  costly,  since  the  bank 
will  ordinarily  require  a  new  title  search  and  other  formalities. 
Moreover  savings  bank  accommodations  are  not  always,  by  strict 
interpretation,  collateral  loans.  For  instance,  a  savings  bank  in 
New  York  or  Massachusetts  may  take  as  security  for  a  loan  a 
real  estate  mortgage  assigned  to  itself;  but  this  is  a  direct  not 
collateral  security,  for  in  becoming  the  assignee,  the  bank  becomes 
the  mortgagee.    Tt  may  not  take  a  mortgage  as  pure  collateral. 

Mortgage  hypothecation,  then,  will  usually  be  undertaken  only 
because  money  is  needed  and  the  mortgage  cannot  be  sold.  It  will 
be  possible  to  borrow  on  a  mortgage,  as  wrell  as  to  sell  it,  only  in 
the  locality  in  which  the  pledged  property  is  situated,  unless  the 
sale  or  loan  is  negotiated  through  a  land  title  company  or  some 
other  kind  of  mortgage  brokers  who  have  moral  or  legal  responsi- 
bility of  sufficient  weight  to  mspive  confidence. 

144.  Bonds  of  comparatively  obscure  corporations,  however 
meritorious,  have  a  restricted  market  also,  but  not  so  restricted  as 
the  mortgage  market.  A  bank  will  loan  to  a  customer  on  a  bond 
unknown  to  it  except  in  a  general  way,  providing  the  borrower  is 
in  good  standing  and  there  is  a  satisfactory  financial  statement  by 
this  issuing  company.  A  perusal  of  the  trust  deed  will  satisfy  any 
reasonable  curiosity  with  regard  to  legal  details.  If  the  institution 
where  the  bond  owner  banks  is  not  capable  of  loaning  discreetly  on 
the  paper,  the  banking  house  of  which  he  bought  the  bond  will 
either  loan  him  on  the  bond  directly,  or  else  refer  him  to  one  of  the 
national  banks  or  trust  companies  with  which  they  are  affiliated  and 
to  which  the  issue  is  acceptable  as  collateral.  A  loan  thus  ne- 
gotiated will  cost  the  borrower  nothing  except  customary  interest 
and  the  nominal  cost  attending  the  transfer  of  funds.  The  bond 
house  will  ask  nothing  for  its  services  and  there  will  be  none  of 
the  vexatious  fees  attending  almost  any  transaction  in  mort- 
gages. 

145.  Tax-Exemption.  Taxation,  in  reference  to  security  invest- 
ments, is  a  subject  of  vital  importance,  because,  where  operative, 
it  cuts  so  deeply  into  the  return  as  to  be  a  hardship. 

Legislators  should  remember  this:  Bonds  and  mortgages  are  the 
only  two  common  forms  of  pare  long  term  investment.  Very  high 
grade  oonds  of  the  land  in  ichich  trustees  are  sanctioned  oy  law  to 
invest,  and  mortgages  of  equal  grade,  net  only  4  per  cent.    A  tax  of 

1  Within  two  or  three  years  this  privilege  was  permitted  savings  banks  in 
Massachusetts. 


BONDS  VERSUS  MORTGAGES  57 

$15  a  thousand  leaves  a  dependent  widow  or  child  with  a  2£  per  cent, 
income.  It  is  equivalent  to  an  income  tax  of  37£  per  cent.  Which, 
then,  is  more  iniquitous,  the  imposition  of  this  tax  or  its  evasion? 
For,  let  it  be  remembered  that  the  tax  on  bonds  is  seldom  paid  except 
by  those  who  can  least  afford  to  pay :  the  beneficiaries  from  invested 
funds.  The  evasion  or  oversight  of  a  mortgage  tax  is  difficult  be- 
cause of  the  general  practice  of  recording  real  estate  mortgages. 

146.  A  study  of  the  4S  or  more  codes  will  surprise  many  who 
think  that  mortgages  have  a  general  advantage  over  bonds  in  the 
matter  of  taxation.  Only  in  Massachusetts,  Connecticut,  New 
Jersey,  Pennsylvania,  Indiana,  Idaho,  Colorado,  California,  Wash- 
ington, Louisiana,  and  in  some  counties  of  Maryland,  are  mortgages 
exempt  from  tax.  In  New  York  they  are  exempt  if  an  initial  record- 
ing tax  of  ^  of  1  per  cent,  is  paid.  If  the  mortgage  secures  a  bond  is- 
sue, the  issue  is  exempt  to  holders  within  the  state.  In  practice  this 
recording  tax  is  paid  by  the  borrowers.  Since  the  civil  loans  of  New 
York  State  are  also  tax  free,  New  York  bonds  and  mortgages  are 
practically  on  an  equal  footing;  but  since  the  amount  of  "  foreign" 
mortgages  held  in  the  state  is  a  small  proportion  of  the  whole, 
whereas  the  amount  of  foreign  bonds  is  much  greater  in  propor- 
tion to  all  bonds,  mortgages  as  a  whole  have  been  more  favored 
than  bonds.  But  for  the  recent  change  see  §  50,  Note.  The  princi- 
ple will  hold  in  other  states  mentioned  where  mortgages  are  not 
assessed.  But  over  against  this  is  the  consideration  that  when 
and  where  both  types  of  securities  are  subject  to  taxation,  bonds 
very  generally  escape,  and  mortgages  do  not. 

147.  Freedom  from  Care.  One  of  the  advantages  of  investments 
over  speculations  is  the  comparative  freedom  from  attention  which' 
investments  enjoy.  But  there  is  great  latitude  within  the  invest- 
ment class  in  respect  to  this  quality.  Mortgages  involve  no  little 
trouble.  Besides  the  pains  of  original  research  at  the  time  of  pur- 
chase and  the  trouble  of  renewal  or  reinvestment  every  few  years, 
there  are  quite  a  number  of  petty  details  that  require  almost  con- 
stant attention.  It  must  be  seen  that  the  tax  bills  and  water  bills 
are  paid ;  that  insurance  is  kept  up  and  assessments  not  allowed  to 
run  too  long.  It  must  be  seen  that  the  property,  if  improved,  is 
not  liable  for  a  building  contract,  and  that  the  buildings  are  kept 
in  repair,  and  that  no  mechanics'  liens  are  attached  for  services 
rendered.  If  the  mortgage  interest  is  delayed,  there  must  be  what 
is  fair  to  call  "  an  exchange  of  personalities  "  and  possibly  fore- 
closure with  resort  to  one's  attorneys.     Relief  from  all  these  petty 


58  BONDS  VERSUS  MORTGAGES 

details  is  to  be  had  by  investment  in  guaranteed  mortgages;  but 
then  the  net  return  is  brought  down  to  the  level  of  the  high  grade 
railroad  bonds  and  the  Western  and  Southern  municipals,  and  the 
comparison  is  no  longer  general. 

148.  Bonds  on  the  other  hand  possess,  almost  in  perfection, 
this  highly-desirable  investment  quality  called  freedom  from  care. 
The  trustee  for  the  bondholders,  nowadays  almost  invariably  a 
trust  company,  is  invested  with  adequate  authority  and  responsi- 
bility to  conserve  the  interest  of  the  bondholders  in  all  those  par- 
ticulars. Failure  to  fulfil  these  duties  imposed  by  the  trust  agree- 
ment renders  the  trust  company  liable. 

Because  of  the  long  life  possessed  by  many  bond  issues,  and  be- 
cause bonds  are  subject  to  responsible  trust  company  supervision, 
the  investor  may  lay  aside  money  in  funded  obligations  where  the 
principal  may  remain  untouched  and  almost  unthought  of  through 
the  lifetimes  of  his  children's  children,  and  the  interest  be  collected 
with  no  more  pains  than  required  to  cash  the  semi-annual  coupons 
or  the  interest  check. 

149.  In  bond  default,  there  is  a  similar,  if  less  gratifying,  free- 
dom from  necessity  to  act.  According  to  the  racy  saying,  it  is  not 
always  preferable  to  be  an  honorary  rather  than  an  active  pall- 
bearer ;  but  in  the  main  more  is  gained  than  lost  by  committing  the 
conduct  of  bond  affairs  to  the  trustee  or  to  a  bona-fide  bondholders' 
protective  committee. 

Very  few  corporations  which  have  sufficient  importance  and  dig- 
nity to  accomplish  the  distribution  of  their  obligations  by  good 
banking  houses,  will  ever  be  wound  up.  Therefore  a  prudent  bond 
buyer  will  almost  never  come  into  the  possession  of  real  property 
as  the  result  of  foreclosure  proceedings.  In  the  readjustment  of 
affairs  he  will  receive  new  securities, — probably  bonds  for  the  most 
part.  He  will  still  remain  a  creditor  of  the  company,  and  an  in- 
vestor. But  when  mortgages  default  in  interest  the  mortgagee  must 
be  prepared  to  protect  the  property  at  foreclosure  sale,  and  if  neces- 
sary, to  buy  it  in.  In  this  event  he  has  the  care  of  it,  and  the 
responsibility  as  a  speculator  in  real  estate.  In  general  the  mort- 
gagee must  expect  that  his  dealings  as  creditor  and  litigant  cannot 
be  kept  on  the  impersonal  plane  that  is  such  a  desirable  aspect  of 
bond  investment. 

150.  Acceptable  Duration.  In  the  third  section  preceding  we 
spoke  of  the  freedom  from  care  made  possible  by  the  varying  dura- 
tion of  bond  issues.  In  general  the  unlimited  choice, — from  pres- 


BONDS  VERSUS  MORTGAGES  59 

ently-inaturing  paper  to  perpetual  loans, — is  no  mean   advantage 
and  weighs  heavily  in  favor  of  this  type  of  investment  (§§  180,  141). 

151.  Acceptable  Denomination.  In  convenience  of  denomination, 
also,  mortgages  suffer  by  comparison.  A  man  who  owns  a  house 
worth  $10,000  wants  to  mortgage  it  for  $6,000  at  5  per  cent.  This 
might  be  a  good  loan,  but  he  cannot  "  get  together "  with  an  in- 
vestor who  has  only  $5,000.  We  will  say  that  the  investor  with 
$5,000  is  unable  to  find  a  desirable  $5,000  mortgage  and  has  to  be 
content  with  a  $4,000  mortgage.  He  is  then  in  the  market  for  a 
$1,000  mortgage;  but  a  first  mortgage  of  this  size  is  not  likely  to 
be  had  on  such  good  property,  relatively,  as  the  larger  mortgage. 
And  the  division  of  the  investment  means  additional  incidental 
costs  and  additional  care  and  attention.  In  these  two  illustrations 
both  borrower  and  lender  are  inconvenienced  by  mortgage  denomi- 
nation. As  to  the  small  investor, — of  the  type  France  knows  well, 
but  America  has  yet  to  recognize:  the  man  with  $100  to  $500  to 
lay  aside  each  year  in  securities,  rather  than  in  the  bank, — real 
estate  mortgages  do  not  often  meet  his  needs;  and  unfortunately 
bonds  do  not,  either,  as  well  as  they  will  ten  years  from  now.  But 
a  few  good  bonds:  government,  municipal,  and  corporation,  may 
always  be  had  in  denominations  of  $100  and  up.  $500  bonds  are 
becoming  quite  common,  especially  among  the  loans  of  public  serv- 
ice corporations.  A  $10,  or  $100,  or  $500  bond  is  as  safe  as  one 
of  larger  par  value;  each  is  merely  a  smaller  share  in  the  same 
large  mortgage. 

152.  One  great  disadvantage  of  the  inadjustable  denomination  of 
mortgages  is  quite  generally  overlooked  in  discussions  of  investment 
theory.  The  mortgage  does  not  admit  the  nice  distribution  of  in- 
vestment risk  which  is  possible  in  smaller  units  of  value.  If  a  man 
has  only  $5,000  upon  which  he  or  his  family  may  be  dependent  it  may 
be  advisable  to  make  five  separate  investments  of  $1,000.  In  this 
way  he  may  protect  himself  by  distribution  of  risk  against  a  total 
loss  of  principal  through  his  own  misjudgment  or  through  unfore- 
seeable misfortune. 

Inadjustable  denomination  also  reduces  the  probability  of  quick 
conversion,  for  it  may  be  easier  to  find  two  buyers  with  $2,500  each 
than  one  buyer  with  $5,000. 

153.  Potential  Appreciation.  There  is  a  good  deal  of  misapprehen- 
sion as  to  the  possibility  and  desirability  of  value-changes  for  in- 
vestments. The  topic  is  discussed  in  its  general  phases,  elsewhere. 
We  are  concerned  here  with  the  relation  of  Appreciation  and  its 


60  BONDS  VERSUS  MORTGAGES 

necessary  correlate,  Depreciation,  to  bonds  and  mortgages.  The 
gist  of  the  matter  is  well  put  in  a  circular  issued  some  time  ago 
by  a  New  York  banking  house. 

"  The  statement  has  been  made  that  real  estate  mortgages  are  always  worth 
par  because  the  principal  will  be  paid  promptly  at  maturity;  but  it  is  obvious 
that  the  same  can  be  said  of  long-time  or  short-time  bonds,  regardless  of  the 
price  at  which  they  are  selling.  The  fluctuation  in  price  is  due  either  to  the 
exigencies  of  others,  or  to  temporary  changes  in  interest  rates,  and  need  not 
disturb  the  investor,  who  has  bought  for  income.  We  would  emphasize  that  the 
investor  receives  the  same  income  annually,  regardless  of  the  price  at  which  his 
security  is  selling. 

"  Fluctuations  in  real  estate  mortgages  are  probably  neither  greater  nor  less 
than  those  of  other  short-time  securities.  But  while  it  is  doubtless  true  that 
a  real  estate  mortgage  cannot  decline  to  the  same  extent  as  a  long-time  bond, 
neither  can  it  appreciate.  An  investor  in  a  real  estate  mortgage  having  a  few 
years  to  run  might  find  his  security  maturing  at  a  period  when  interest  rates 
were  very  low,  and  he  could  only  extend  or  invest  at  a  rate  materially  below 
that  which  he  had  formerly  received.  On  the  other  hand,  an  investor  in  long- 
term  bonds,  if  he  makes  his  purchase  at  a  time  when  bonds  are  soiling  below  their 
normal  quotations,  has  the  benefit  of  the  high  yield  until  the  maturity  of  the 
security.  Or,  if  he  has  funds  to  invest  when  interest  rates  are  low  and  long- 
time bonds  are  high,  he  can  easily  obtain  short-time  securities,  such  as  well- 
secured  notes  or  equipment  obligations,  and  replace  these  when  the  long-time 
securities  can  be  obtained  on  satisfactory  terms." 

154.  But  appreciation,  or  depreciation, — to  a  greater  extent  in 
bonds  and  to  a  less  extent  in  mortgages  because  of  their  respective 
average  denominations, — may  be  the  result  of  something  more  sub- 
stantial than  mere  price  fluctuations  due  to  market  conditions  and 
changes  in  the  rates  for  money.  It  may  be  due  to  changes  in  the 
value  of  the  pledged  property.  From  the  investment  point  of  view, — 
always  looking  first  to  recovery  of  the  principal,— no  matter  when 
conversion  may  be  necessary, — mortgages  appear  to  have  the  ad- 
vantage in  their  apparently  restricted  possibility  for  price  change; 
but  if  forced  to  sudden  liquidation,  the  mortgage  investment  is  liable 
to  severe  loss  because  there  is  no  demand  for  the  paper.  From  the 
speculative  point  of  view  the  owner  of  the  mortgage  is  at  a  dis- 
advantage, for  if  the  value  of  the  property  increases  the  investment 
enhances  the  security  for  the  loan,  but  through  this  very  inconver- 
tibility it  cannot  add  to  the  principal  of  the  investment ;  but  if  the 
value  diminishes  the  security  is  lessened,  with  possible  diminishment 
of  the  principal  from  realization  under  foreclosure. 

The  bond  owner,  however,  although  receiving  only  the  fixed  in- 


BONDS  VERSUS  MORTGAGES  61 

come,  not  only  benefits  from  the  enhancement  in  equities,  by  in- 
creased security  for  his  bonds,  but  he  enjoys  the  possibility  of 
realizing  on  his  investment  before  maturity  more  than  he  put  into 
it.  The  tendency  of  well  chosen  long  term  investments  is  to  increase 
in  value  with  time  and  the  advantages  of  such  an  increase  accrue 
to  the  bondholder,  but  not  to  the  mortgage  holder,  except  in  in- 
creased security. 

155.  Conclusion.  A  summary  of  investment  characteristics  sug- 
gests that  both  bonds  and  mortgages  satisfactorily  fill  the  essential 
requirements  of  time  loans  as  to  safety  of  principal  and  interest,  and 
as  to  fair  net  return.  However,  though  there  is  little  to  choose  be- 
tween them  in  the  investment  essentials,  only  bonds  have  the 
highly-desirable  qualities  of  convertibility,  freedom  from  care,  con- 
venience of  denomination,  and  possibility  of  substantial  apprecia- 
tion. Each  of  these  accessory  advantages  has  been  shown  to  con- 
tribute to  investment  security  in  its  broader  interpretation,  and  to 
the  total,  if  not  to  the  fixed,  net  return.  Therefore  it  is  a  defensible 
position  that  bonds  are  a  better  channel  of  investment  for  those 
who  will  acquaint  themselves  with  the  essential  principles  of  bond 
investment. 


CHAPTER  VII 
LISTED  VERSUS  UNLISTED  BONDS 

156.  One  of  the  stock  opinions  arising  from  half-truths  in  finan- 
cial matters,  which  bond  salesmen  are  obliged  to  combat,  is  this,  that 
"  listed  bonds  are  the  only  kind  to  buy."  The  statement  is  often 
accompanied  by  a  complacent,  knowing  air,  a  not-so-green-as-1-look 
manner,  that  is  the  more  exasperating  because  usually  unwarranted. 
Let  us  then  apply  our  touchstone  of  investment  virtues  to  bonds 
listed  and  unlisted,  to  see  where  the  truth  lies. 

157.  Of  the  nine  or  ten  desirable  elements  in  an  ideal  invest- 
ment, onlj-  three  can  be  advanced  seriously  as  being  affected  by 
listing  on  the  stock  exchanges :  the  security  of  the  investment,  the 
negotiability  of  it,  and  the  rate  of  income  it  yields. 

158.  Security.  As  to  security,  it  is  true  that  the  listing  commit- 
tees of  some  of  the  exchanges  require  certain  definite,  informing 
statements  concerning  the  companies  whose  obligations  and  paper 
they  pass  upon;  and  it  is  also  true  that  the  New  York  Stock  Ex- 
change requires  that  all  bonds  dealt  in  there  should  be  certified  to 
as  regards  genuineness  by  a  trust  company,  and  that  the  institution 
of  this  requirement  was  the  cause  of  the  present  vogue  of  trust 
company  certification;  but  the  information  necessarily  possessed 
by  any  listing  committee  concerning  the  worth  of  its  listed  securi- 
ties is  blackest  ignorance  compared  with  the  intimate  knowledge 
any  bond  house  must  have  of  the  condition  of  a  company  whose 
obligations  it  floats.  The  listing  committee  is  handed  a  financial 
statement  and  brief  answers  to  set  questions.  If  the  loan  was 
previously  underwritten  by  a  banking  house  that  wishes  the  issue 
listed,  further  information  may  be  gratuitously  forthcoming;  but 
the  committee,  unlike  the  house,  is  not  obligated  to  employ  engi- 
neers, auditors,  and  attorneys  in  the  interest  of  all  concerned. 

Bankers  in  investment  securities  are  principals:  as  a  rule  they 
own  the  bonds  they  sell ;  stock  exchanges  are  merely  associations  of 
agents  who  sell  for  the  account  of  others;  so  it  is  natural  that  real 
critical  scrutiny  should  come  only  from  the  bond  houses.  What 
possible  assurance  of  safety,  in  the  ordinary  sense,  can  be  found 

62 


LISTED  VERSUS  UNLISTED  BONDS  63 

in  listing  when  Erie  common  and  Southern  Railway  common  are  to 
be  found  on  the  New  York  board,  and  Standard  Oil  is  not ;  and  when 
Wabash  Pittsburg  Terminal  Second  4s  (which  sold  from  4  to  11| 
cents  on  the  dollar  in  1910)  are  listed,  and  Massachusetts  3£s  are 
not,  and  when  in  fact  the  only  state  loans,  except  of  New  York, 
come  from  south  of  Mason  and  Dixon's  line. 

Thus  far,  then,  we  may  decide  that  stock  exchanges  sometimes 
afford  assurance  of  authenticity  and  validity  (which  are  real  prob- 
lems only  in  civil  loans),  but  not  of  the  safety  of  an  investment, 
as  such.  We  have,  however,  considered  security  in  a  broader,  but  no 
less  real  sense.  No  matter  how  active  may  be  the  market  for  an 
issue,  the  more  haste  in  selling  the  less  the  price  obtained.  The 
cost  of  speed  may  be  from  one-eighth  to  several  per  cent.  But  to 
a  greater  or  less  extent  the  markets  of  the  larger  exchanges  are 
"  free  markets,"  and,  barring  manipulation,  prices  move  in  response 
to  supply  and  demand.  But  the  market  created  by  responsible  bond 
houses  for  their  "  specialties  "  is  artificial,  and  governed  more  by 
considerations  of  policy.  It  is  likely  to  be  unnaturally  favorable  to 
those  who  have  bought  the  bonds  of  the  house  that  has  fathered  them, 
but  very  unfavorable  to  all  others.  Although  unprovable,  it  is  prob- 
ably true  that  the  average  margin  between  "  bid  "  and  "  asked  "  of 
listed  bonds  is  much  less  than  half  that  of  unlisted  bonds,  and  the 
loss  due  to  the  "  higgling  of  the  market "  correspondingly  less. 

159.  Negotiability.  Negotiability,  in  its  two  aspects  of  market- 
ability and  hypothecary  value,  has  much  more  of  a  bearing  on  the 
subject.  It  is  unquestionably  true  that  the  average  listed  bond  can 
be  more  readily  sold  or  hypothecated  than  the  average  unlisted. 
An  examination  of  the  reasons  may  assist  some  in  the  choice  of  their 
purchases. 

160.  In  the  first  place  listing  does  not  create  a  market.  In  about 
173  railroad  issues  listed  on  the  New  York  Stock  Exchange  (or  ap- 
proximately 22  per  cent,  of  all)  there  were  no  exchange  transactions 
at  all  in  1911.  Nor  were  there  sales  in  about  11  listed  public  serv- 
ice and  industrial  issues^  ©r  approximately  7  per  cent,  of  all.  In 
a  great  many  other  issues  there  were  sales  of  only  one,  two,  or 
three  bonds  during  the  year.  Surely  a  bond  cannot  be  said  to  be 
fairly  active,  with  probabilities  of  a  ready  market  at  close  to 
"going"  quotations,  unless  the  sales  per  week  average  at  least  10 
railroad  bonds  of  thousand  dollar  denomination.  In  1911  there 
were  about  101  issues,  or  approximately  13  per  cent,  of  the  totaL 
that  were  thus  active. 


64  LISTED  VERSUS  UNLISTED  BONDS 

161.  It  is  only  fair  to  say  that  the  market  for  many  inactive 
issues  is  stronger  than  indicated  by  the  volume  of  transactions. 
Some  divisional  railroad  issues  of  highest  merit  are  not  dealt  in 
because  they  are  laid  away  in  strong  boxes  as  investments  to  be 
held  till  maturity.  On  the  other  hand,  some  issues  are  not  sold 
on  the  exchange  because  nobody  will  buy  them. 

162.  Although  listing  does  not  create  a  market  it  facilitates  trans- 
actions and  thereby  encourages  marketability.  People  are  now 
familiar  with  the  mechanics  of  exchange  transactions;  they  know 
to  whom  to  apply  when  they  wish  to  buy  or  sell  exchange  bonds; 
they  know  what  the  brokerage  cost  of  all  dealings  will  be,  and  they 
know  they  can  ascertain  at  any  time  the  price  realized  by  the  latest 
exchange  sale,  and  the  highest  or  lowest  prices  over  a  period.  These 
are  genuine  advantages  not  to  be  despised. 

163.  Because  there  are  genuine  advantages  enjoyed  by  listed 
bonds  one  should  not  overlook  the  fact  that  listing  and  market- 
ability do  not  stand  in  relation  of  cause  and  effect,  but  rather  that 
both  are  the  effects  of  a  common  cause,  namely  the  size  and  reputa- 
tion of  issues.  Mere  bulk  in  an  issue  implies  the  economic  im- 
portance of  the  obligor  company;  it  implies  comparatively  wide 
distribution  among  investors,  and  a  general  knowledge  of  the  issue 
and  a  growing  demand  for  it  if  the  security  warrants.  It  may  be 
worth  while  to  list  such  bonds  simply  because  they  are  likely  to  be 
dealt  in  extensively.  Exchanges  exist  primarily  for  the  purpose  of 
making  commissions.  A  study  of  listed  bond  sales  will  show  an 
intimate  relation  between  the  size  of  the  issue  and  the  volume  of 
sales.  The  underlying  railroad  divisional  bonds  are  now  com- 
paratively inactive.  The  great  blanket  railroad  refunding  mortgages 
(all  but  three  or  four  of  which  are  listed  at  New  York)1  show 
comparatively  heavy  transactions.  The  relation,  then,  that  exists 
between  size  and  volume  of  transactions  is  the  relation  that  exists 
between  size  and  listing. 

164.  Current  Versus  TJncurrent  Bonds.  Therefore,  so  far  as  a  ready 
market  is  concerned,  the  question  should  not  be  that  of  listed  versus 
unlisted  bonds,  nor  quite  even  of  active  versus  inactive,  but  rather 
of  current  versus  uncurrent,  i.e.,  the  question  as  to  whether  or  not 

1  Three  of  these  exceptions  are  the  Duluth,  South  Shore  and  Atlantic  Con- 
solidated 4s  (of  which  all  the  outstanding  honds  are  owned  by  the  Canadian  Pa- 
cific), the  New  York,  Ontario  and  Western  General  4s,  and  the  Wisconsin  Central 
First  and  Refunding  4s. 


LISTED  VERSUS  UNLISTED  BONDS  65 

on  short  notice  one  can  purchase  or  sell  a  security  at  somewhere  near 
the  same  price.  In  other  words,  whether  or  not  transactions  are 
numerous,  the  bid  and  asked  price  of  current  bonds  must  be 
close  together  and  hold  good  for  the  amount  of  bonds  one  has  to 
buy  or  sell.  It  is  merely  circumstantial  that  a  majority  of  such 
issues  are  listed. 

Then  the  buyer  who  throws  up  his  hands  at  unlisted  bonds  usually 
makes  one  of  two  errors:  Either  he  calls  what  he  wants  by  the 
wrong  name,  or  else  he  buys  what  he  doesn't  need.  If  current  bonds 
are  what  he  wishes  he  may  get  them  of  the  curb,  or  at  the  bond 
counter,  as  well  as  on  the  board.  But  if  he  buys  for  investment 
(the  purpose  for  which  funded  loans  exist)  may  he  not  ask  himself 
whether  for  his  needs  currency  is  worth  what  it  costs?  He  is  much 
more  likely  to  say,  "  If  I  buy  this  inactive  bond  for  95,  I  may  have 
to  sell  it  for  90  to  get  rid  of  it,"— than,  "  If  I  buy  this  active  bond 
for  95  which  I  could  turn  around  now  and  sell  again  for  94^,  includ- 
ing commissions  both  ways,  I  shall  be  paying  5  for  activity  and  90 
for  investment  value." 

165.  This  is  no  plea  for  unlisted,  or  even  for  uncurrent,  bonds. 
It  is  merely  an  appeal  for  the  application  of  sound  investment  prin- 
ciples to  all  bond  buying  and  selling.  The  fact  that  there  are  a 
thousand  financial  houses  doing  a  general  bond  business  x  in  the 
United  States  and  Canada  is  sufficient  evidence  of  the  demand  for 
unlisted  securities.  The  commissions  on  all  exchange  transactions 
would  barely  pay  the  postage  and  stationery  of  these  houses,  if  it 
would  do  that.  It  is  fitting  that  the  fallacy  of  listed  bonds,  as 
such,  be  exposed  in  order  to  emphasize  the  desirability  of  analyzing 
one's  investment  needs  before  buying,  since  every  investment  merit 
has  to  be  paid  for,  and  lessens  the  net  return  that  is  the  primary 
object  of  investment  as  distinguished  from  safe  deposit. 

166.  Hypothecary  Value.  In  making  loans  upon  collateral,  other 
conditions  enter  in,  which  give  listed  bonds  a  decided  advantage. 
A  bank  has  not  the  time  or  personal  interest  to  investigate,  as  a 
purchaser  should,  the  character  of  collateral  security.  From  the 
nature  of  commercial  banking,  personal  credit  is  the  specialty; 
collateral  credit  or  credit  instruments  are  secondary.  The  national 
bank  and  the  trust  company  look  upon  listed  securities  as  authentic ; 
reference  is  easy  to  current  quotations  as  the  basis  for  appraisal 
and  loan.    Therefore  listed  securities  are,  in  general,  more  accept- 

1  There  are  over  four  thousand  bond  offices  in  America. 


66  LISTED  VERSUS  UNLISTED  BONDS 

able.    In  taking  them  the  bank  moves  along  the  line  of  least  resist- 
ance; the  loan  clerk  has  less  thinking  to  do. 

167.  It  is  of  little  purport  to  our  argument,  but  the  fact  remains 
that  the  highly  sensitive  and  elastic  condition  of  the  New  York 
loan  market  is  due  to  this  general  subservience  to  the  quotations  of 
the  hour.  Investment  value  does  not  receive  due  consideration. 
Objections  to  the  New  York  banking  system  of  call  loans  on  ex- 
change collateral  is  growing  stronger  and  conditions  will  surely 
improve.  Meanwhile,  the  holder  of  uncurrent  bonds  must  expect 
to  be  at  the  pains  of  laying  the  merits  of  the  loan  he  desires  before 
the  investment  board,  as  he  would  have  to  lay  the  merits  of  a  real 
estate  mortgage  before  the  board  of  a  savings  bank.  Relief  from 
personal  pains  has  to  be  paid  for  in  investments  as  in  transportation. 

168.  Net  Income.  The  bulk  of  bonds  purchased  by  national  banks 
and  insurance  companies  should  be  current, — perhaps  listed.  In- 
stant marketability  may  mean  much  to  them.  But  why  should  the 
treasurer  of  a  university,  or  the  trustee,  or  the  private  investor  who 
is  debating  whether  he  shall  buy  bonds  or  real  estate,  pay  the  price 
of  convertibility?  He  has  no  grievance  if  it  takes  him  six  months 
to  find  a  buyer  for  his  business  block  at  a  fair  price.  Simply  because 
bonds  are  paper  and  represent  no  tangible  property  he  should  not 
confuse  slow  convertibility  with  investment  merit. 

169.  The  greatest  need  of  most  people  and  institutions  which 
buy  for  pure  investment  is  the  highest  return  compatible  with  good 
security.    Very  few  listed  bonds  meet  this  requirement. 

170.  The  System  of  Bend  Houses  as  an  Investment  Exchange.  Prob- 
ably the  error  at  the  bottom  of  the  listed-bond  fallacy  is  this :  the 
difference  between  stock-market  and  bond-market  conditions  is  not 
generally  appreciated.  In  several  respects  stocks,  unlisted  and  un- 
current, are  not  so  desirable  as  listed.  Stocks  as  a  class  sadly  need 
even  the  slight  oversight  that  listing  achieves;  and  as  for  salability, 
even  high  grade  shares,  such  as  those  of  the  New  England  banks  and 
mills,  suffer  badly,  at  times,  in  liquidation,  for  lack  of  a  broader 
market.  Too  generally  are  unlisted  and  uncurrent  stocks  inter- 
changeable terms.  But  not  to  such  an  extent,  bonds.  The  great 
system  of  American  bond  houses,  which  has  no  like  in  any  European 
country,  is  really  an  immense  exchange  in  itself,  reaching  out  with 
its  branch  offices  and  traveling  representatives  over  the  more  settled 
parts  of  the  United  States  and  Canada.  This  system,  with  the  aid 
of  telegraph  and  telephone,  fulfils  for  most  purposes  the  legitimate 
functions  of  an  investment  exchange.    There  is  of  course  no  similar 


LISTED  VERSUS  UNLISTED  BONDS  67 

system  for  stocks — no  federation  of  houses,  handling  uncurrent  and 
unlisted,  as  well  as  listed  stocks,  that  through  the  medium  of  an  ex- 
tended clientele  and  a  highly  developed  street  brokerage  business 
puts  buyer  and  seller  in  reasonably  quick  communication.  Unlisted 
stocks,  therefore,  are  not  on  the  same  plane  of  convertibility  as  un- 
listed bonds. 

171.  So  satisfactory  is  this  system  of  bond-interchange  that  over 
90  per  cent,  of  transactions  in  listed  bonds  (it  is  estimated)  take 
place  outside  of  the  exchanges.  If  one  wished  to  buy  or  sell  People's 
Gas  Light  and  Coke  Company  Refunding  5s  he  would  probably  do 
slightly  better  with  a  well-known  Chicago  bond  house  than  on  the 
New  York  or  Chicago  Exchanges;  and  who  would  purchase  our 
national  public  funds  on  the  New  York  Exchange  without  first  con- 
sulting the  quotations  of  a  bond  house  specializing  in  United  States 
Governments?  In  New  York  there  seemed  little  prospect  of  im- 
mediate business  in  February,  190S,  when  81^  was  bid  for  Chicago 
and  Eastern  Illinois  Refunding  4s  and  92^  was  asked.  Examine 
the  circulars  of  the  big  bond  houses  and  note  their  holdings  of  bonds 
listed  in  New  York:  Chicago,  Burlington,  and  Quincy  (Illinois 
Division)  3|s,  New  York  Central  Refunding  3^s,  Lake  Shore  First 
Mortgage  3£s,  etc.,  a  fair  indication  of  where  the  real  market  for 
most  listed  bonds  is. 

172.  Another  source  of  misunderstanding  is  the  fact  that  all 
exchange  business  is  done  at  the  uniform  commission  of  |  per  cent., 
whereas  a  seller  of  bonds  in  the  open  market  believes,  with  good 
reason,  that  his  house  sometimes  makes  several  times  this  amount 
in  brokerage  Consciously  or  not  the  larger  commission  is  be- 
grudged. The  very  much  greater  effort  and  expense  necessary  to 
market  inactive  unlisted  issues  are  not  appreciated.  In  a  real  estate 
transaction  it  would  readily  be  perceived  and  acknowledged  that  it 
is  better  to  pay  an  agent  5  per  cent,  to  sell  a  house  worth  $20,000  at 
its  value,  rather  than  to  pay  another  agent  1  per  cent,  to  make  a 
quick  sale  of  the  same  property  for  $18,000. 

173.  The  Unreliability  of  Some  Listed  Quotations.  Although  ex- 
change quotations,  especially  at  New  York,  are  a  very  convenient 
reference  for  purposes  of  appraisal,  hypothecation,  and  sale,  they 
are  not  always  to  be  trusted,  especially  as  the  basis  of  value  for  large 
amounts  of  bonds.  Suppose  that  an  institution  held  $500,000  of  a 
certain  railway  loan  which  was  93^  bid  95f  asked.  The  inexperi- 
enced inference  might  be  that  these  bonds  would  sell  for  94  or  there- 
abouts.    It  might  well  be,  however,  that  $100,000  bonds  were  offered 


68  LISTED  VERSUS  UNLISTED  BONDS 

at  95f  and  only  three  bonds  were  bid  93£  and  that  only  a  handful 
were  wanted  between  93£  and  91£.  As  a  true  basis  for  valuation 
or  sale  how  does  listing  help  these  bonds?  They  might  as  well  be 
part  of  a  big  municipal  issue,  that  offered  for  sale  will  seek  its  invest- 
ment price  level  with  facility  if  offered  direct  to  bond  houses  that  do 
an  institutional  business. 

174.  Manipulation  of  one  sort  or  another  occasionally  has  its 
bearing  on  quotations.  Some  years  ago  Lake  Street  Elevated  5s 
were  87  bid  on  the  Chicago  Exchange.  On  the  appearance  of  two 
bonds  for  sale  at  that  price  the  quotation  vanished  in  thin  air  and 
no  demand  materialized  until  the  bonds  were  offered  down  10  or 
12  points.  A  sale  was  finally  effected  off  the  board,  presumably  in 
order  not  to  hurt  the  feelings  of  banks  that  may  have  been  loaning 
75  cents  to  the  dollar  on  them. 

The  two  great  issues  of  the  American  Telephone  and  Telegraph 
Company  are  listed  on  both  the  Boston  and  New  York  Exchanges. 
In  the  Spring  of  1908  millions  of  them  were  still  in  the  hands  of 
the  underwriters.  For  a  while  it  was  then  possible  to  purchase  them 
on  the  Street  for  about  three-quarters  of  a  point  less  than  on  the 
board.  One  who  is  familiar  with  the  flotation  of  listed  railroad 
issues  knows  that  they  too  are  not  always  left  to  seek  their  natural 
investment  level. 

175.  Conclusion.  The  not  uncommon  preference  for  listed  bonds, 
therefore,  is  often  founded  on  misconceptions.  Listing  would  always 
be  desirable  if  it  did  not  cost ;  but  except  in  an  indirect  sense  there 
is  no  added  security  from  it.  For  hypothecation  fairly  marketable 
bonds  of  quality,  whether  on  the  board  or  not,  will  serve.  If  an 
instantaneous  market  is  the  prime  consideration,  choose  an  active 
listed  bond ;  but  be  sure  it  is  active.  For  ordinary  investment  pur- 
poses, however,  whether  buying  or  selling,  the  quotation  sheet  may 
be  ignored;  the  real  market  is  among.the  bond  houses.  Listed  bonds 
are  not  necessarily  current;  current  bonds  are  not  necessarily  listed. 
And  neither  current  nor  listed  bonds  are  necessarily  the  most  de- 
sirable— at  the  price. 


CHAPTER  VIII 

THE    CLASSIFICATION    AND    DESCRIPTION    OF    BONDS: 
ACCORDING  TO  THE  CHARACTER  OF  THE  OBLIGOR 

176.  One  who  seeks,  in  a  scholarly  temper,  to  classify  and  describe 
the_phenomena  of  funded  debt,  is  met  with  the  obstacles  and  per- 
plexities that  beset  the  course  of  any  scientific  investigation  of  scope. 
For  merely  practical  purposes,  the  possible  divisions  of  material 
are  limited  only  by  the  concepts  and  terminology  already  estab- 
lished by  business  uses.  For  instance,  as  bonds  are  bought  above  or 
below  par  they  are  Premium  or  Discount  Bonds;  as  government 
issues  sold  at  home  or  abroad  they  are  Internal  or  External  Loans. 
Even  the  very  color  of  the  indenture  can  give  us  the  Blue  Bonds  and 
Brown  Bonds  of  South  Carolina. 

177.  The  Four  Schemes  of  Classification.  But  apart  from  these 
accidental  and  occasional  divisions  there  are  four  schemes  of  classi- 
fication  of  sufficient  importance  and  extent  to  warrant  develop- 
ment; for  the  full  title  of  almost  every  bond  is  derived  from  some 
or  all  of  these  four;  and  the  possible  number  of  classes  and  titles 
of  bonds  is  limited  only  by  the  possible  combinations  of  names  from 
those  four  schemes  of  classification.    Bonds  are  divided,  therefore: 

I.  According  to  the  character  of  the  issuing  corporation, 

II.  According  to  the  character  of  the  security  for  the  bonds. 

III.  According  to  the  purpose  or  function  of  the  issue. 

IV.  According  to  the  conditions  attending  payment  of  principal 
and  interest. 

I.    Classification  According  to  the  Character  of  the  Obligor. 

178.  The  most  thorough-going  classification — that  which  divide* 
the  subject  best  for  study  from  the  legal,  economic,  and  financial 
standpoints — is  according  to  the  character  of  the  issuing  corpora- 
tion, or  obligor.1  Therefore  the  second  and  third  parts  of  this  book 
are  devoted  to  Civil  Loans  and  Corporation  Loans,  respectively,  and 

1  In  one  class  of  bonds  described  in  these  pages  (Residuary  Estate  Bonds)  the 
obligor  is  not  a  corporation  but  an  individual. 

«9 


70      CLASSIFICATION  AND  DESCRIPTION  OF  BONDS 

the  succeeding  chapters  deal,  for  the  most  part,  with  the  types  of 
bonds  as  derived  from  this  scheme  of  classification. 


Civil  Loans    < 


Government 
Loans 


< 


'  United  States  Bonds 
Bonds  of  Dependencies 


Territorial  Bonds 
State  Bonds 

Municipals  Proper 


Municipal 
Loans 


Corporation 
Loans 


Public  Utility 
Bonds 


Industrial 
and 

Miscellaneous 
Bonds 


Transportation 
Bonds 


Quasi-Municipals 

Railroad  Bonds 
Steamship  Bonds 
Ferry  Bonds 
Express  Company  Bonds 
Interurban  Railway  Bonds 

Street  Railway  Bonds 
Gas  Bonds 
Electric  Light  Bonds 
Water  Bonds 
Water  Power  Bonds 
Telephone  Bonds 

Reclamation  Issues 

Timber  Land  Bonds 
Real  Estate  Bonds 
Mining  Company  Bonds 


City  Bonds 

Bonds  of  Incorporated  Towns 

Bonds  of  Incorporated  Villages 

County  Bonds 

Parish  Bonds 

Township  Bonds 

Borough  Bonds 

Precinct  Bonds 

Assessment  Bonds,  i.e.  Bonds  of 


Taxing  Districts 


Irrigalion  Bonds 
Levee  Bonds 
Drainage  Bonds 


Irrigation  District 
Bonds 

Carey  Act  Bonds 

Bonds  of  Private 
Projects 


179.  Some  words  in  explanation  of  this  partition  will  not  be 
amiss.  Of  course  the  nomenclature  is  open  to  dispute, — as  always. 
The  writer  has  never  seen  the  exact  classification  here  presented. 
The  bi-partite  division  into  Civil  and  Corporation  Loans  cannot  be ' 
successfully  attacked.  Civil  Loans  are  supported  and  acquitted  by  I 
taxation ;;gnndj£jlJT_iji  a  very  necessary  factor  of  safety.  Corpora- 
tion Loans  are  maintained  and  discharged  by  earnings  from  opera- 
tion; the  security  generally  is  a  mortgage  upon  property  or  collat- 
eral. Civil  loans  are  generally  debentures;  corporation  loans 
generally  liens.  Municipal  Loans  are  also  corporation  loans, — 
public  corporation  loans ;  but  in  this  country  the  word  corporation, 
when  unqualified,  denotes  the  company,  rather  than  the  munici- 
pality.1 

1  The  English   apply  the  word  corporation  to  the  municipality,  and  use  the 
word  company  for  private  corporation. 


ACCORDING  TO  THE  CHARACTER  OF  THE  OBLIGOR     71 

180.  As  each  species  of  bond  is  taken  up  in  the  proper  place,  its 
order  and  relation  to  its  fellows  will  be  fully  disclosed.  There  is 
no  subsequent  reference,  however,  to  Transportation  Bonds  as  a 
subdivision.  The  characteristics  are  few  that  bind  transportation 
companies  and  their  obligations,  as  a  whole.  Interurbans,  to  be  sure, 
are  slowly  uniting  Railroads  and  Street  Railways  in  a  common  serv- 
ice; but  the  security  characteristics  of  Steamboat,  Ferry,  and  Ex- 
press Companies  are  not  so  unified.  Under  the  Railroad  Rate  Law, 
however,  even  the  Express  Companies  are  classed  as  common  carriers 
and  are  subject  to  the  Interstate  Commerce  Commission.  Other- 
wise their  obligations  might  be  more  property  classified  under  "  In- 
dustrials and  Miscellaneous."  It  will  be  understood,  then,  that 
Transportation  Bonds  constitute  a  new,  and  still  loosely  united 
group,  and  the  line  of  demarcation  between  it  and  Street  Railway 
Bonds  of  the  Public  Utilities  group  is  merely  the  distinction  be- 
tween companies  that  are  federally  supervised  and  those  that  arej 
rpgmlflteri  by  franchise  and  ordinance. 

181.  Railroad  bonds  are  usually  given  the  position  in  the  scheme 
here  occupied  by  Transportation  bonds,  and  they  well  deserve  the 
prominence.  But  since  there  is  a  perceptible  tendency  to  recognize 
the  more  logical  classification,  it  should  receive  encouragement. 
Interurban  Bonds,  in  these  pages,  are  treated  with  Street  Railway 
Bonds,  since  there  are  not  sufficient  data  accessible  concerning  the 
former  to  warrant  a  separate  chapter.  Express  Company  Bonds 
are  not  discussed  at  all,  since  they  are  not  of  sufficient  number  or 
importance  in  the  investment  field.  Other  omissions  have  been  men- 
tioned in  the  Preface. 

182.  Reclamation  Issues,  in  the  Industrial  and  Miscellaneous 
section,  may  be  a  strange  term  to  some;  but  there  is  sufficient  unity 
within  the  group,  as  will  be  seen  by  reading  the  chapters  so  entitled, 
to  justify  the  appellation,  which  to  be  sure  is  getting  to  be  fairly 
common  among  those  who  are  in  touch  with  Western  bond  finance. 

The  bonds  of  many  kinds  of  companies  are  not  included  within 
the  list ;  but  the  groups  are  sufficiently  comprehensive  as  they  stand, 
to  make  easy  further  classification  with  reference  to  the  obligor. 


CHAPTER  IX 

THE    CLASSIFICATION    AND    DESCRIPTION    OF    BONDS: 
ACCORDING  TO  THE  SECURITY  FOR  THE  BONDS 

183.  The  second  scheme  of  classification  is  still  less  conclusive, 
because  exceptions  to  the  divisions  are  very  numerous,  and  it  is  often 
hard  to  decide  whether  the  title  of  a  bond  (viz.  Improvement  Mort- 
gage Bond)  is  more  significant  of  security  or  purpose. 

184.  Simple  Obligations.  It  will  be  observed  that  in  this  second 
classification,  also,  the  main  division  is  twofold:  into  Simple  Obli- 
gations and  Reinforced  Obligations.  The  commoner  appellations 
"Unsecured"  and  "Secured  Obligations "  seem  hardly  inevitable 
to  express  the  division.  On  their  face  they  seem  to  imply  less 
security  for  the  first  division.  But  the  contrary  is  the  case:  it  is 
because  of  the  superiority  of  the  first  class  as  a  class  that  its 
obligations  can  be  floated  without  guaranty  or  pledge  of  specific 
property;  for  in  this  <?lass  of  Simple  Obligations  Civil  Loans  (both 
government  and  municipal  debentures)  greatly  preponderate  in 
amount  and  importance  over  Corporate  Debentures.  Ordinarily  it 
is  when  a  municipality  or  its  obligation  is  weak,  that  it  offers  lien 
security.  Special  Assessment  Bonds  and  Irrigation  District  Bonds 
usually  pledge  the  property  benefited.  The  principle  applies,  in  a 
measure,  to  corporation  issues  also.  A  mortgage  bond  is  almost 
always  better  than  a  corporate  debenture  of  the  same  company; 
but  few  weak  companies  can  successfully  float  debentures. 

185.  Corporate  Debentures.  In  this  country,  although  not  neces- 
sarily abroad,  the  word  Debenture  is  the  generic  term  for  all  forms 
of  unsecured  corporate  obligations.  Formerly  debentures,  with  us, 
were  sometimes  secured  by  property ;  and  the  term  Mortgage  Deben- 
tures, was  commonly  used  for  funded  loans  collaterally  secured. 
But  the  growing  recognition  of  a  discriminating  terminology  is 
limiting  the  use  of  debenture  as  aforesaid,  in  spite  of  the  fact  that 
there  is  no  ground  in  etymology  for  the  restriction. 

186.  To  the  word  Bond,  custom  has  given  the  prerogative  of 
representing  all  subdivided  interest-bearing  contracts  for  the  future 
payment  of  money  that  are  drawn  with  formality,  whether  they  are 

73 


ACCORDING  TO  THE  SECURITY  FOR  THE  BONDS     73 


Simple 
Obligations 


Civil  Loans 


Corporate 
Debentures 


Guaranty- 
Security 


Certificates  of  Indebtedness 

Plain  Bonds 

Notes 

Debenture  Income  Bonds 

Preference  Income  Bonds 

Receiver's  Certificates 

Assumed  Bonds 
Guaranteed  Bonds 
Endorsed  Bonds 
Stamped  Bonds 
Joint  Bonds 


Reinforced    ; 
Obligations   > 


Lien 
Security 


Lien 
on 
Person- 
alty 


Paper 
Collateral 


Rolling 
Stock 


Funds        — 


i   Property 


Lien 
on 

Realty 


Mortgage 
Incidence  "* 


Mortgage 
Priority 


Collateral  Trust  Bonds 
Railway  Trust  Bonds 
Collateral  Notes 
Collateral  Mortgage  Bonds,  or 
Mortgage-Collateral  Trust  Bonds 
First  Mortgage  Trust  Bonds 
Collateral  income  Bonds 
Certificates  of  Beneficial  Interest 
Stock  Trust  Certificates,  or 
Trust  Certificates,  or 
Stock  Interest  Certificates 
Residuary  Estate  Bonds 

Car  Trust  Certificates 
Car  Trust  Bonds 
Equipment  Bonds 

Sinking  Fund  Bonds 

Municipal  Mortgage  Bonds 

Real  Estate 

(Railroad)  Real  Estate  Bonds 

Land  Grant  Bonds 

Farm  Mortgage  Bonds 

Divisional  Bonds 

Extension      " 

Refunding  and  Extension  Bonds 

Purchased  Line         " 

Bridge  " 

Ferry  " 

Dock 

Wharf 

Terminal  " 

Prior  Lien  Bonds 

Underlying  Bonds 

Overlying  Bonds 

Senior  Issues 

Junior  Issues 

First  Mortgage  Bonds 

Refunding  First  Mortgage  Bonds 

First  Refunding         "  " 

First  and  Refunding  Mortgage  Bonds 

Consolidated  Mortgage  Bonds 

Consolidated  and  Refunding  Mtg.  Bonds 

Consolidated  First  Mortgage  Bonds 

First  and  Consolidated  Mortgage  Bonds 

First  Consolidated  "  " 

General  Mortgage  Bonds 

General  First  Mortgage  Bonds 

General  and  First  Mortgage  Bonds 

First  Lien  and  General  Mortgage  Bonds 

First  General  Mortgage  Bonds 

Unifying  Mortgage  Bonds 

Mortgage  Income  Bonds 

Secondhand  Third  Mortgage  Bonds 

Second  Ref'd'g,  Consol.,  &Gen.  Mtg.  Bonds 

Improvement  Mortgage  Bonds 

Debenture  Mortgage  Bonds 

Mortgage  Debentures 


74       CLASSIFICATION  AND  DESCRIPTION  OF  BONDS 

secured  or  unsecured,  whether  the  interest  is  imperative  under  all 
conditions,  or  not,  as  in  the  case  of  Income  Bonds. 

187.  The  technical  strength  of  almost  all  corporation  debentures, 
except  Receivers'  Certificates,  depends  on  the  duration  of  the  loan 
and  on  the  amount  and  stability  of  equities  in  assets  and  earning 
power  over  and  above  prior  liens  and  charges.  If  these  equities  are 
sufficient  during  the  continuance  of  the  loan,  interest  charges  will 
be  met,  and  if  they  are  sufficient  at  maturity,  the  company  will  have 
a  basis  of  credit  for  refunding  that  part  of  the  issue  which  has  not 
previously  been  amortized. 

Fresent  equitable  assets  protecting  debentures  may  be  conserved, 
as  in  the  case  of  the  Chicago,  Milwaukee,  and  St.  Paul  Debenture 
4s,  by  express  agreement  on  the  part  of  the  obligor  that  no  new 
mortgage  shall  be  created  without  securing  the  debentures  under  it, 
equally  and  ratably.  The  trust  agreement  for  the  American  To- 
bacco 6s  and  4s  is  still  stronger  in  its  protective  measures.  Al- 
though these  loans  are  not  secured  by  mortgage  on  property,  they 
are  first  and  second  charges,  respectively,  on  all  the  company's 
properties,  income  and  profits,  now  and  hereafter,  to  which  any 
subsequent  mortgage  loan  would  be  subject. 

In  want  of  lien  security  or  a  trust  agreement  such  as  that  men- 
tioned for  debentures,  there  is  no  recourse  to  foreclosure  proceedings. 
The  bondholder  is  merely  a  preferred  creditor.  He  may  resort  to 
proceedings  under  the  contract,  either  to  have  a  receiver  appointed 
or  to  obtain  a  judgment  and  to  levy  execution;  but  this  is  all  he 
can  do. 

188.  Certificates  of  Indebtedness  are  the  simplest  of  the  several 
varieties  of  debentures.  They  are  sometimes  issued  by  states — Vir- 
ginia, for  instance — and  then  may  be  merely  an  expression  for  inter- 
minable loan.  When  issued  by  municipal  or  private  corporations,  on 
the  other  hand,  they  are  likely  to  be  temporary  in  nature,  and  of  spe- 
cial denominations  to  suit  predestined  uses,  such  as  the  deferred  pay- 
ment of  road  and  building  contracts.  Among  municipal  debentures 
Town  Warrants,  and  their  kin,  are  somewhat  analogous  Certificates 
of  Indebtedness.  The  English  call  their  interminable  municipal 
loans  "  Corporation  Stock,"  and  their  interminable  company  loans 
"  Debenture  Stock." 

189.  Plain  Bonds  is  a  homely  term,  fallen  somewhat  into  disuse, 
for  debentures  of  the  pure  type:  i.e.  those  without  reinforcement 
of  lien,  or  even  sinking  fund.  The  Boston  and  Maine  has  adopted 
this  term  for  its  debentures.     Plain  Bonds  would  differ,  if  at  all, 


ACCORDING  TO  THE  SECURITY  FOR  THE  BONDS      75 

from  Certificates  of  Indebtedness,  only  in  stricter  conformity  with 
bond  usage  respecting  denomination,  etc. 

190.  Corporation  Notes,  in  bond  parlance,  are  to  be  distinguished 
from  ordinary  commercial  notes  only  in  respect  to  formality  in  the 
drawing.  The  title  is  reserved  particularly  for  debentures  of  short 
duration,  and  for  those  that  have  dispensed  with  the  formality  of 
an  indenture  under  seal.  The  New  York,  New  Haven,  and  Hartford 
Debenture  4s  of  1956  could,  with  propriety,  hardly  be  termed  Notes; 
but  the  Debenture  4|s  of  May,  1911,  and  the  5s  of  1909-1912  are 
properly  so  called.  It  is  an  undue  extension  of  the  word  Note,  ac- 
counted for  by  its  recent  popularity,  that  the  10-year  secured  obliga- 
tions of  the  Deepwater  Tidewater  Railway  Company  are  called  Notes. 
The  Tidewater  notes  in  turn  suggest  another  fact,  that  secured  notes 
more  often  have,  as  pledge,  collateral  securities  than  direct  mortgage. 
The  Pennsylvania  3-year  5  per  cent,  notes  of  1910  have  been  among 
the  most  prominent  of  these  collaterally  secured  issues. 

During  the  past  few  years  short  term  notes  have  been  the  resort 
of  companies  wishing  to  obtain  funds  at  times  when  money  rates 
would  not  permit  the  economical  issuance  of  long  term,  low  interest 
bearing  securities.  It  is  usually  the  intention  to  provide  for  the 
payment  of  these  notes  at  maturity  with  Refunding  Bonds.  If  the 
money  market  has  not  improved  sufficiently  to  warrant  this,  the 
notes  may  be  extended,  or  new  notes  issued  to  take  their  place. 

Other  things  being  equal,  a  company's  short  term  notes  are  a 
safer  investment  than  its  long  term  debentures,  for  the  equities  in 
assets  and  earnings  can  be  predicted  with  greater  sureness  for  a 
short  than  for  a  long  period. 

191.  Debenture  Income  Bonds  is  the  full  title  for  a  class  of 
obligations  commonly  called  Income  Bonds,  but  it  cannot  be  con- 
veniently dropped  because  not  a  few  income  bonds  have  some  sort 
of  mortgage  security  for  the  principal — generally  a  junior  mort- 
gage, although,  as  the  very  name  implies,  debenture  income  bonds 
have  no  lien  security  for  the  principal,  yet  the  interest — up  to  a 
maximum  rate  of,  say,  5  per  cent. — may  be  a  lien  on  the  net  earn- 
ings and  probably  on  the  net  income,  if  earned.  Income  bonds  are 
cumulative  or  non-cumulative,  like  preferred  stock  (which  they  re- 
semble) ,  depending  upon  whether  a  default  on  all  or  any  part  of  the 
interest  one  year  shall  or  shall  not  be  made  up  another  year  when 
the  interest  has  been  earned.  Income  Bonds  take  precedence  over 
all  classes  of  stocks,  for  although  both  are  liabilities,  only  the  bonds 
are  obligations. 


7t>      CLASSIFICATION  AND  DESCRIPTION  OF  BONDS 

192.  Sometimes  Debentures  or  Junior  Mortgage  Bonds  are  pay- 
able, as  to  interest,  during  tbe  first  few  years  of  life  only  when  the 
income  has  been  sufficient  to  earn  the  interest.  During  these  years 
they  are  Debenture  Income  or  Mortgage  Income  Bonds,  although 
it  is  quite  likely  that  they  will  be  called  by  other  names. 

193.  Preference  Income  Bonds,  or  briefly,  Preference  Bonds,  is 
sometimes  used  as  synonymous  with  Income  Bonds,  but  more  descrip- 
tively, when  there  are  two  or  more  series,  like  First,  Second,  and 
Third  Preferred  Stocks.  The  interest  on  Preference  Income  Bonds 
is  paid  on  each  series  as  earned,  in  the  order  of  the  series.  Perhaps 
the  best  illustration  among  American  railroad  bonds  are  the  First, 
Second,  and  Third  Preference  Incomes  of  the  Central  of  Georgia 
Railway. 

194.  It  is  evident  that  the  holders  of  Debenture  Incomes  of  any 
type  are  often  at  the  mercy  of  the  directors.  Railroad  accounting, 
especially  that  of  intrastate  roads,  can  make  the  worse  appear  the 
better  reason.  He  was  a  fool  or  a  knave  who  first _said_thaj:  figures 
cannot  lie.  A  member  of  a  Bondholders'  Protective  Committee  for 
one  of  the  railroad  income  issues  now  in  default  says  that,  to  freeze 
out  the  income  bondholders,  the  road  in  question  has  been  badly 
mismanaged  and  expenses  have  been  run  up  to  90  per  cent,  of 
earnings.  This,  of  course,  left  no  revenue  to  be  applied  to  the  in- 
come bonds,  so  that  the  holders  have  sued  for  their  interest.  These 
suits  have  been  tried  in  the  lower  and  the  higher  courts  and  have 
in  all  cases  been  successful. 

Interest  on  the  incomes  has  been  withheld  on  purely  technical 
grounds.  The  question  at  issue  is  whether  the  profitable  parts  of 
this  company  shall  be  included  in  reckoning  earnings.  For  instance, 
the  company  owns  a  steamboat  line,  from  which  the  earnings  are 
about  $500,000  a  year  net.  Inasmuch  as  the  interest  on  the  First 
Incomes  is  only  $200,000  when  paid  to  the  full  5  per  cent.,  it  may 
easily  be  seen  that  the  charge  could  be  met.  But  the  company's 
officials  maintain  that  this  steamboat  line  is  not  an  integral  part 
of  the  system.  The  courts  have  finally  decided  that  it  is  such  a 
part  of  the  system  that  the  railroad  must  apply  the  equity  of  the 
steamship  company  to  the  payment  of  the  interest  of  the  incomr 
bonds. 

195.  Receivers'  Certificates  bring  us  to  the  opposite  extreme  oi 
safety.  If  Debenture  Incomes  are  the  weakest  possible  form  of 
corporation  bond,  Receivers'  Certificates  are  perhaps,  as  a  class, 
the  strongest,  although  "  nnseenrerl."    This  is  because  of  their  origin 


ACCORDING  TO  THE  SECURITY  FOR  THE  BONDS     77 

in  necessity  and  law.  They  are  issued  by  the  receiver,  at  the  order 
of  the  court,  in  order  to  raise  money  necessary  to  the  continuance 
of  some  form  of  public  service,  the  cessation  of  which  would  be 
contrary  to  public  interest  and  policy. 

If  for  no  other  reason,  to  make  them  successful  instruments  for 
raising  money  under  the  necessarily  unfavorable  circumstances,  they 
have  precedence  in  payment  over  all  other  funded  obligations;  but 
they  rank  second  to  wages  and  supplies,  to  all  necessary  current  ex- 
penses, and  to  mechanics'  liens.  If  the  certificates  are  not  paid 
during  receivership,  they  are  assumed  by  the  railroad  company  on 
reorganization. 

196.  Reinforced  Obligations.     There  are  two  ways  by  which  the 
original  simple  obligation  of  a  bond  may  be  modified  or  reinforced : 
by  additional  pledge  of  word,  or  by  pledge  of  property.     An  addi- 
tionai  pledge  of  word  is  a  guaranty  and  a  pledge  of  property  is  a     "hr 
lien.     Let  us  deal  first  with  the  guaranty.  "%^ 

197.  Guaranty  Security.      There  is  very  general  confusion  as  to        ^>  0 
Assumed  and  Guaranteed  Bonds.    In  the  acquisition  of  one  company  ^a 


by  another,  very  probably  it  will  be  found  that  the  purchased  com-  /,y 
pany  had  bonds  outstanding  on  its  property.    This  is  most  commonly  * '  %  ki 
the  case  in  railway  consolidations.    If  the  purchased  company  loses      -  >  ^t; 
its  corporate  identity, — "  non  est/'  as  the  law  says, — then  the  bonds  3$K 
become  the  direct  obligation  of  the  purchasing  company.    They  are  o      ^p 
jasKiinififl  prerise1y_.as  the  mortgage  on  a  house  is  assumed  by  the     $£.  o^ 
man  who  buys  the  house.     If  the  assumed  bonds  were  mortgage       v  *|s  V 
bonds,  the  collateral  credit,  the  mortgaged  property,  remains  the 
same.    It  is  the  personal  credit  that  has  changed. 

198.  If  the  consolidation  is  merely  partial,  and  the  purchased    ^ 
company  stin_jnaintains  a  separate  corporate  .existence,  then  the         5u/Mt 
personal   credit   may   remain  unchanged,   but  the  bonds   may   be  v       •-*„ 
strengthened  by  the  guaranty  of  the  holding  company.     In  this  ^^^^^ 
case  thev  are  not  assumed.    The  terms  of  the  guaranty  may  beon  ^  "^  ^Wj 
the  bonds  themselves  or  in  a  separate  document.    Sometimes,  after  S^t*«i>>^ 
issuance,  the  bonds  will  have  placed  upon  them  the  name  of  the  **<$. 
holding,  or  some  other  interested  company.    A  guaranty  is  implied 
thereby  and  is  enforceable  at  law,  just  like  an  ordinary  indorsed 

note.    These  are  called  Indorsed  Bonds. 

199.  The  term  Indorsed  Bonds  is  extended  to  include  another 
class.  Any  writing  foreign  to  the  text  (whether  or  not  in  the  nature 
of  a  guaranty)  which  is  found  upon  credit  instruments  that  are 
formally  drawn,  may  be  a  hindrance  to  their  hypothecation  and 


78      CLASSIFICATION  AND  DESCRIPTION  OF  BONDS 

sale.  Such  writing  brings  the  paper  within  the  category  of  Indorsed 
Bonds  by  the  rule  of  the  New  York  Stock  Exchange  that  "  Coupon 
Bonds"  issued  to  bearer,  having  an  indorsement  upon  (hem  not 
properly  pertaining  to  them  as  a  security,  must  be  sold  specifically 
as  "  Indorsed  Bonds  "  and  are  not  a  delivery  except  as  "  Indorsed 
Bonds." 

Bonds,  for  instance,  secured  by  mortgage  on  real  property  within 
New  York  Stale,  on  which  the  mortgage-recording  tax  of  ^  of  one  per 
cent,  is  paid,  will  have  that  fact  indorsed  or  stamped  upon 
them. 

200.  Very  suggestive  of  indorsed  securities,  but  with  wider  sphere 
of  application,  are  Stamped  Bonds.  Kfainnpiri  aprnss  tho  fiu>t*  of  tbe 
instrument  may  be  the  following:  "  Subject  to  provisions  s<>t  fnvflh 
on  back  thereof."  The  provisions  mentioned  may  be  a  digest  of  the 
agreement  and  supplemental  mortgage  (if  any),  that  become  effect- 
ive on  acceptance  of  the  bond  by  the  purchaser.  The  agreement  may 
relate  to  the  establishment  of  a  sinking  fund,  to  the  disposal  of 
unissued  numbers,  or  to  any  other  change  in  plan  to  benefit  the  loan. 
Ordinarily  the  trust  company  that  acts  as  trustee  will  certify  to 
the  authenticity  of  the  indorsement. 

But  paper  may  be  stamped  for  other  purposes  than  reinforcement 
of  security.  Of  itself  the  stamping  merely  implies  an  addendum. 
The  temporary  receipts  for  the  New  York  Telephone  Co.  4-Js  of  '39 
were  stamped  with  late  but  necessary  information  regarding 
coupons  and  accrued  interest.  Naturally  Extended  Bonds  are  very 
often  stamped  bonds. 

201.  There  is  still  another  sense  in  which  we  may  speak  of 
stamped  bonds.  Bonds  that  may  be  subject  to  a  stamp  tax  or  a  tax 
the  payment  of  which  is  indicated  when  a  stamp  like  that  for  post- 
age is  affixed,  are  Stamped  Bonds  when  the  tax  is  paid. 

202.  In  purchasing  any  form  of  Guaranteed  Bonds  the  two  main 
considerations  are  (1)  that  the  pledged  property  is  sufficient  se- 
curity in  itself,  for  the  payment  of  the  bonds,  with  interest,  and 
(2)  that  the  form  of  the  guaranty  is  such  as  to  compel  the  guaran- 
teeing company  to  meet  any  deficiencies  on  the  part  of  the  primary 
obligor  by  payment  of  the  amount  of  these  deficiencies  to  the  trustee 
for  the  bondholder. 

203.  In  the  upbuilding  of  the  great  American  railroad  systems 
the  status  of  the  bonds  of  merged  and  subsidiary  companies  has  had 
a  thorough  trying  out.  Experience  has  proven  that  guaranties 
have  not  always  been  enforceable  against  the  makers,  because  the 


ACCORDING  TO  THE  SECURITY  FOR  THE  BONDS      79 

guaranties  stipulate  no  definite  remedy  in  ease  of  default.  If  all 
goes  well  the  guaranteeing  corporation  will  never  be  directly  liable. 
But  suppose  that  a  corporation  which  has  guaranteed  bonds  bearing 
interest  January  and  July  should  go  into  the  hands  of  a  receiver 
in  February.  The  issuing  corporation  fails  then  also.  The  direct 
obligor  cannot  default  till  July.  The  guaranty  cannot  be  a  fixed 
liability  till  July.  It  is  merely  a  contingent  liability:  a  contract. 
The  receiver  has  a  right  to  affirm  or  disaffirm  contracts.  He  can  dis- 
affirm this  guaranty.  If,  however,  the  bonds  had  been  assumed,  the 
liability  would  have  been  fixed,  and  the  receiver  could  discharge 
it  only  by  paying.  The  bondholders  would  then  have  the  actual 
mortgaged  property  and  be  entitled  to  rank  pro  rata  with  the  gen- 
eral creditors  of  the  assuming  corporation.  We  need  not  go  into 
the  question  as  to  whether  the  receiver  ever  could  be  held  to  the 
guaranty  if  it  had  been  given  expressly  in  part  payment  for  a  lease. 
Our  purpose  is  merely  to  show  the  inferiority  of  Guaranteed  to 
Assumed  Bonds. 

204.  Guaranties  are  by  no  means  confined  to  railroad  companies, 
or  even  to  private  corporations;  municipalities  sometimes,  though 
not  frequently,  guarantee  or  assume  the  bonds  of  corporations  like 
water  companies,  which  they  take  over  for  municipal  operation  or 
ownership,  or  the  securities  of  which  they  wish  to  strengthen  for 
market  purposes. 

205.  Guaranties  of  bonds  are  sometimes  assumed.  If  through 
physical  merger  Railroad  A  absorbs  Railroad  B,  which  has  guaran- 
teed bonds  of  Railroad  C,  then  Railroad  A  assumes  the  guaranties 
of  the  bonds  of  Railroad  C. 

206.  Guaranty,  like  registration,  may  apply  to  the  principal  of 
bonds,  or  to  the  interest,  or  to  both.  Columbia,  South  Carolina, 
guarantees  the  interest  of  |200,000  Canal  bonds,  but  the  Columbia 
Water  Power  Co.  is  responsible  for  the  principal. 

207.  An  interesting  illustration  of  the  fact  that  security  of 
principal,  and  security  of  interest  are  not  the  same,  may  be  cited 
in  connection  with  the  guaranty.  Four  or  five  years  ago  one  of 
the  strongest  national  banks  in  New  England  guaranteed  by  in- 
dorsement on  each  bond  the  payment  of  the  principal  sum,  at  ma- 
turity, of  an  issue  of  about  a  quarter  of  a  million  dollars  of  bonds 
of  a  promotion  company.  The  unsophisticated  investor  would 
naturally  suppose  that  if  the  strong  national  bank  thought  well 
enough  of  the  issue  to  guarantee  the  payment  of  the  principal  at  the 
maturity  date,  there  certainly  could  be  no  question  about  the  in- 


80      CLASSIFICATION  AND  DESCRIPTION  OF  BONDS 

terest.  But  the  terms  of  the  guaranty  failed  to  state  that  the 
bank  received  from  the  proceeds  of  the  sale  of  each  bond  a  sum 
sufficient,  when  compounded  at  3£  per  cent.,  to  equal  the  principal 
at  the  distant  maturity  date.  Rumor  has  it  that  although  this 
device  was  within  the  law,  the  Controller  of  the  Currency  dis- 
countenanced it  as  bad  banking  practice. 

208.  Guaranty,  therefore,  as  a  dependable  addition  to  lien 
security,  should  be  such  that  on  default,  payment  of  both  principal 
and  interest  become  an  immediate  and  direct  obligation  of  the 
sponsor. 

But  it  so  happens  that  default  by  the  subsidiary  company  is  mosi 
likely  at  the  very  time  that  the  major  company  itself  is  in  trouble; 
for  the  same  general  business  conditions  probably  affect  them  both. 
What,  then,  is  the  relative  standing  of  various  claimants  if  the  system 
is  reorganized  or  goes  into  receivership  ?  Even  holders  of  debentures 
fare  better  than  holders  of  guaranteed  securities  as  far  as  the  parent 
company  is  concerned,  for  the  former  are  preferred  and  the  latter 
are  general  creditors.  The  claim  of  the  debenture  obligations  of  the 
New  York,  New  Haven,  and  Hartford  Railroad  would  take  pre- 
cedence over  the  claim  of  preferred  shares  of  the  New  England  In- 
vestment and  Securities  Company,  which  are  guaranteed  by  the 
New  Haven  Road;  for  the  owners  of  the  Debentures  are  first  pre- 
ferred creditors  of  the  general  income  of  the  road;  but  the  owners 
of  the  New  England  Investment  shares  would  merely  share  on  equal 
footing  with  the  other  general  creditors  after  the  debenture  holders 
were  satisfied. 

209.  Assumed  bonds,  on  the  other  hai^d,  take  their  place  with  the 
other  bonds  of  the  system  according  to  priority  of  lien,  etc.;  and 
even  though  certain  issues  may  have  been  guaranteed  prior  to  the 
assumption  of  the  new  bonds,  those  assumed  have  the  preference 
as  obligations. 

210.  A  community  of  interest  such  as  exists  where  two  or  more 
railroads  desire  to  use  the  same  bridge  or  terminal  station  gives  rise 
to  bonds  jointly  guaranteed.  Thus  the  Boston  Terminal  Company 
has  issued  3£s,  which  are  to  be  sure  a  first  mortgage  on  its  lands 
and  buildings,  but  in  addition  they  are  jointly  guaranteed  by  the 
New  York,  New  Haven,  and  Hartford,  the  Boston  and  Albany,  the 
New  England,  the  Boston  and  Providence,  and  the  Old  Colony 
Railroads.  A  stronger  assurance  is  had  when  the  guaranty  is  both 
"  joint  and  several,"  i.e.  when  each  guaranteeing  company  is  held 
contingently  liable  for  the  whole  amount. 


ACCORDING  TO  THE  SECURITY  FOR  THE  BONDS      81 
211.   Joint  Bonds,  in  the  field  of  funded  debt,  correspond  to  the    ,        ^ 


joint  promissory  notes  of  the  commercial  world.     These  bonds  re-    A,,       '-a, 
<       ceived  greater  prominence,  as  a  class,  on  the  issuance  by  the  Great   L," 
S*>  Northern  Railway  and  the  Northern  Pacific  Railway,  of  their  joint   ,       <"  <*_-> 
&/  Collateral  Trust  4s,  secured  by  the  stock  of  the  Chicago,  Burlington,  ""^M  €  „ 
and  Quincy^at  a  valuation  of  |200  per  share.    In  this  instance  the 
security  is  triple:  the  entire  loan  is  the  direct  obligation  of  each 
railroad,  and  there  is  the  pledge  of  the  collateral  as  well.     There 
are  two  credit  contracts  and  one  collateral  contract. 

212.  Joint  Bonds  usually  are  the  "  joint  and  several  "  direct  obli- 
gations of  two  or  more  companies.  They  may  be  simple  debentures, 
or  collateral  trust  loans  or  mortgage  loans.  They  may  be  issued  by 
any  types  of  private  corporation.  A  mining  issue  to  be  noted  is  the 
Norfolk  and  Western-Pocahontas  Coal  Co.  Joint  4s  of  1941.  They 
are  the  direct  obligation  of  the  Norfolk  and  Western  Railway  Com- 
pany and  the  Pocahontas  Coal  and  Coke  Co.,  but  as  between  the  two, 
the  liability  is  in  the  Pocahontas  Company.  The  lien  security  is  a 
mortgage  on  coal  lands.  In  the  case  of  the  C.  B.  &  Q.  Joint  4s,  each 
of  the  issuing  roads  guarantees  the  fulfilment  of  that  part  of  the  obli- 
gation undertaken  by  the  other.  Joint  bonds  should  be  distin- 
guished from  issues  with  joint  guaranty. 

213.  Lien  Security.  In  contrast  with  the  additional  security  fur- 
nished by  guaranty,  which  rests  on  personal  credit,  is  the  form  of 
security  furnished  by  lien,  which  rests  on  the  segregation  of  specific 
assets,  against  which  the  creditor  can  satisfy  his  demands  in  case 
the  personal  credit  of  the  obligor  is  not  sufficient. 

214.  But  since  in  business  practice  default  in  any  sort  of  corpora- 
tion loan,  whether  guaranteed  or  not,  will  in  all  probability  have  to 
be  satisfied,  ultimately,  out  of  the  pledged  property,  the  first  step  in 
investigating  a  valid  lien  is  to  appraise  the  property.  Even  if,  as  a 
measure  of  expediency,  the  obligor  company  which  defaults  on  its 
mortgage  obligation  is  reorganized,  without  foreclosure  proceedings, 
the  readjustment  of  its  obligations  will  be  on  the  basis  of  property 
value  and  priority  of  claim  thereto. 

215.  Bonds  with  lien  security  are  divided,  according  to  the  nature 
of  the  property  mortgaged,  into  bonds  secured  on  personalty  and 
on  realty.  The  personalty,  in  turn,  that  commonly  offers  as 
security  for  bonds,  is  paper  collateral,  rolling  stock,  and  sinking 
funds. 

216.  Lien  on  Personalty.  All  funded  issues  that  have  as  their 
principal  reinforcement,  not  a  direct  mortgage  on  real  property, 


82      CLASSIFICATION  AND  DESCRIPTION  OF  BONDS 

but   the  deposit   in   trust   of  paper  security,   are  properly   called 
Collateral  Trust  Bonds. 

They  come  into  being  in  this  way.  A  corporation,  owning  or  in 
control  of  subsidiary  companies  or  properties,  may  for  reasons  in- 
numerable, not  wish  to  dispose  of  either  the  shares  or  bonds  of 
these  subsidiaries.  For  instance,  the  short  term  note  of  a  big  rail- 
road system  of  the  Middle  West,  secured  by  the  first  mortgage  bond 
of  a  new  division  in  Louisiana,  may  sell  for  a  better  price  than  the 
divisional  bond  itself,  as  the  direct  obligation  of  the  unknown  sub- 
sidiary company,  even  if  guaranteed  by  the  parent  company.  There- 
fore railroad  companies  make  loans  in  their  own  name,  and  in  lieu 
of  a  direct  mortgage  pledge  the  securities  of  their  subsidiaries. 

217.  The  investment  worth  of  Collateral  Trust  Bonds  varies  (1) 
according  to  the  credit  of  the  issuing  corporation,  (2)  according  to 
the  value  of  the  securities  hypothecated,  and  (3)  according  to  the  de- 
gree of  protection  afforded  by  the  deed  of  trust.  What  may  be  said 
to  constitute  the  credit  of  a  corporation  is  too  large  a  subject  to  be 
treated  here.    It  is  developed  in  the  first  chapter  on  Railroad  Bonds. 

218.  A  tendency  to  wide  fluctuations  is  undesirable  in  collateral, 
for  an  increase  in  its  market  value  is  ultimately  the  avail  of  the 
owners  of  the  collateral,  but  a  decrease  in  market  value  undermines 
the  security  of  the  bonds.  Therefore  stock,  with  its  comparatively 
unstable  worth,  is  not  so  desirable  as  bonds.  The  Atlantic  Coast 
Line,  Louisville  and  Nashville  Collateral  Trust  4s  of  1952  are  se- 
cured by  deposit  of  Louisville  and  Nashville  stock.  A  severe  panic 
is  likely  to  find  the  value  of  the  collateral  shrunk  considerably  be- 
low the  par  of  the  bonds. 

219.  It  is  desirable  that  the  collateral  should  be  the  securities  of 
a  corporation  disassociated  as  to  the  nature  and  sources  of  its 
revenues,  so  that  a  set  of  conditions  that  will  unfavorably  affect  the 
credit  of  the  issuing  company,  will  not  necessarily  work  to  the  detri- 
ment of  the  collateral. 

220.  But  the  most  conspicuous  failure  of  collateral  trust  bonds 
has  lain  in  the  weakness  of  the  trust  agreement  as  a  protection  to 
the  bondholders.  Experience  from  past  defaults  is  now  corroborated 
in  the  Detroit,  Toledo,  and  Ironton,  Ann  Arbor  Collateral  Trust 
Notes.  Although  the  Notes  were  due  Dec.  1,  1908,  and  were  in  de- 
fault some  time  previously,  the  owners  were  not  able  for  two  years 
to  come  into  possession  of  their  Ann  Arbor  Stock.  Collateral  should 
be  deposited  with  the  trustee  for  the  bondholders  on  terms  that 
would  render  it  to  the  holders  upon  default  that  they  might  imme- 


ACCORDING  TO  THE  SECURITY  FOR  THE  BONDS      83 

diately  enter  upon  the  physical  property  represented  by  their  se- 
curities. Against  partial  dismantlement  of  the  property  that  is 
directly  or  indirectly  pledged,  the  collateral  trust  mortgage  may 
well  incorporate  provisions  clothing  the  bondholders  with  sufficient 
proprietary  rights  to  prevent,  without  their  consent,  the  sale  of 
parts  of  this  property,  or  the  consolidation  of  it  with  other  prop- 
erties, or  the  issuance  of  other  securities  on  the  property. 

221.  Substitution  of  collateral  should  not  be  permitted  except  on 
definite  prearranged  terms.  The  shifting  of  collateral  is  an  unsat- 
isfactory feature  of  Real  Estate  Mortgage  Bonds.  Issues  that  per- 
mit substitution  of  the  collateral  are  called  Convertible  Collateral 
Trust  Bonds.  Strictly,  any  Collateral  Trust  issue  that  is  convertible 
may  be  so  called.  Presumably  in  proportion  as  the  bonds  are  con- 
verted the  collateral  will  be  released.  Sometimes,  the  bonds  are  con- 
vertible into  their  own  collateral.  Thus  the  Hudson  Companies  Con- 
vertible (collateral)  6s  of  1910  and  1911  are  convertible  into  the 
Hudson  and  Manhattan  Company  First  Mortgage  4|s. 

222.  Railway  I'rust  Bonds  is  merely  a  title  for  collateral  trust 
bonds  issued  by  railroads. 

223.  Collateral  Notes  do  not  differ  from  collateral  bonds  except 
in  the  temporal  and  formal  characteristics  that  may  distinguish 
bonds  from  notes,  in  general. 

224.  Collateral  Mortgage  Bonds  are  Collateral  Trusts  that  by 
reason  of  the  securities  pledged  are  indirectly  secured  by  mortgage 
upon  property.  Real  Estate  Mortgage  Bonds  are  of  this  class. 
(See  Chapter  NXIX.)  It  is  not  necessary  even  that  the  immediate 
paper  of  deposit  be  of  the  realty  mortgage  class,  provided  that  the 
ultimate  reinforcement  of  the  obligation  is  a  lien. 

225.  Illustrative  of  the  possibilities  of  indirect  liens,  the  Wall 
Street  Journal  cites  the  St.  Louis  and  San  Francisco  5-year 
4£  per  cent,  notes  which  were  retired  Dec.  1,  1908.  "  These 
are  secured  by  all  the  stock  of  the  St.  Louis,  San  Francisco  and  New 
Orleans  Railroad,  and  by  $6,263,777  St.  Louis,  San  Francisco  and 
New-  Orleans  Extension  4  per  cent,  bonds,  which  are  again  secured 
on  the  1st  mortgage  bonds  of  the  St.  Louis,  San  Francisco  and  New 
Orleans  Railroad,  which  are  a  direct  lien  on  232.74  miles  of  good 
railroads.  In  each  case  the  entire  issue  of  bonds  is  deposited  as 
collateral. 

"  When  the  investor  looks  at  this  note  he  thinks  he  is  looking  at 
something  about  four  steps  removed  from  a  direct  lien.  When  he 
goes  further  in  his  analysis,  he  finds  that  he  holds  the  only  out- 


84      CLASSIFICATION  AND  DESCRIPTION  OF  BONDS 

standing  lien  on  232.74  miles  of  railroads.  His  issue  of  notes  is  the 
only  security  held  by  the  public  which  would  get  money  out  of  the 
sale  of  this  road  in  receivership.  All  the  others  are  in  the  hands 
of  trustees,  who  would  collect  the  debt,  turn  it  over  to  the  next 
trustee,  until  finally,  the  trustees  of  this  note  would  turn  it  over  to 
the  investor,  who  would  probably  be  surprised  to  get  it.  The  only 
difference  would  be  that  each  trustee  would  want  the  usual  fee." 

226.  Mortgage-Collateral  Trust  Bonds  is  a  title  synonymous  with 
Collateral  Mortgage  Bonds. 

227.  First  Mortgage  Trust  Bonds  are  Collateral  Mortgage  Bonds, 
the  collateral  for  which,  immediately,  or  at  some  remove,  is  a  first 
mortgage  upon  real  property.  An  illustration  of  the  type  with 
immediate  mortgage  collateral  are  the  Louisville  and  Nashville  First 
Collateral  Trust  5s  of  1931.  The  St.  Louis  and  San  Francisco  Notes 
just  mentioned  were  of  the  indirect  mortgage  collateral  type. 

228.  Collateral  Income  Bonds  may  be  noted  as  a  class  which  has 
arisen,  under  an  unnecessarily  complicated  system  of  railway  finance, 
combining  the  characteristics  of  two  classes,  collateral  bonds  and 
incomes,  which  we  have  treated  separately.  The  collateral  reinforces 
the  payment  of  the  principal,  but  has  no  bearing  on  the  payment  of 
interest,  which  is  dependent  on  earnings. 

229.  Certificates  of  Beneficial  Interest  is  an  abortive  "  security  " 
of  the  Collateral  Income  type.  It  does  not  merit  a  separate  para- 
graph except  to  call  attention,  to  the  extremes  to  which  the  English 
language  on  the  one  hand  and  the  inspiring  faith  of  the  investor  on 
the  other,  can  be  drawn  on  by  ingenious  efforts  to  raise  funds  without 
offering  adequate  recompense. 

The  design  of  the  issuing  company  may  be  to  retain  control  of  a 
subsidiary  through  the  voting  power  without  tying  up  the  capital 
necessary  to  own  a  majority  of  the  stock.  The  stock  is  deposited  in 
a  voting  trust,  and  against  it  are  issued  Certificates  of  Beneficial 
Interest,  i.e.  interest  in  the  earnings,  and  in  the  equitable  assets 
if  the  company  liquidates.  To  attain  somewhat  different  ends  the 
plan  may  be  applied  to  any  sort  of  paper  for  collateral,  as  well  as 
stock. 

If  the  collateral  is  non-maturing  the  certificates  may  be  of  inde- 
terminate duration.  At  maturity  they  may  be  payable  in  money  or 
in  the  securities  that  they  represent.  The  basis  of  conversion  and  the 
scope  and  force  of  any  guaranty  will  have  to  be  interpreted  from 
the  trust  deed.  Each  issue  will  be  a  law  unto  itself;  generalization 
is  unprofitable. 


ACCORDING  TO  THE  SECURITY  FOR  THE  BONDS      85 

230.  Since  the  informing  principle  of  these  Certificates  of  Bene- 
ficial Interest  is  the  voting  trust  agreement  made  effective  by  the 
pooling  of  securities,  we  may  place  in  the  same  category  Trust  Cer- 
tificates, a  generic  term  like  the  preceding,  and  Stock  Trust  Cer- 
tificates, and  Stock  Interest  Certificates,  titles  of  like  signification, 
but  always  referring  to  corporate  shares.  All  these  Certificates  are 
properly  classified  among  bonds  when  there  is  an  obligation  to  pay 
principal,  interest,  or  both.  Most  of  them,  also,  by  nature,  are 
collateral  trust  bonds ;  and  when  this  is  the  case  they  are  classified 
as  such  by  the  Interstate  Commerce  Commission. 

The  St.  Louis  and  San  Francisco  has  several  issues  of  Stock  Trust 
Certificates.    They  will  repay  study. 

231.  Residuary  Estate  Bonds  are  a  collateral  type  which  have 
the  distinction  of  being  the  only  bonds  mentioned  in  these  pages 
that  are  not  public  or  private  corporation  securities.  They  are 
issued  by  persons  who  have  legal  rights  to  moneys  or  merchantable 
effects,  fees,  or  entail,  receivable  at  a  future  time  under  the  terms  of 
wills.  The  rights  may  be  to  the  principal  or  to  the  interest  in  the 
property  bequeathed.  They  are  secured  by  a  collateral  instrument 
which  transfers  this  right  to  the  purchaser  of  the  instrument.  The 
right  should  be  made  absolute  by  previous  admission  to  probate 
without  contest. 

The  banking  house  gives  to  the  beneficiary  who  decides  to  bond 
his  prospects  the  amount  of  the  bond,  less  the  brokerage  and  the 
cost  of  an  annuity  (purchased  of  some  insurance  company),  which 
will  probably  have  the  same  duration  as  the  testator's  "  expectation 
of  life,"  and  bear  the  same  rate  of  interest  as  the  bond.  The  annuity, 
made  payable  to  the  buyer  of  the  bond  if  the  beneficiary  dies  be- 
fore the  bond  matures,  protects  the  interest,  but  not  the  principal, 
during  the  expectation  of  life.  If  the  testator  dies  within  this  period 
the  bond  owner  obtains  the  principal  of  his  loan  so  much  the  sooner, 
and  thus  increases  that  part  of  the  net  yield  on  his  investment  rep- 
resented by  the  difference  between  the  discount  cost  of  the  bond  and 
par.  Since  the  testator  may  live  beyond  this  period  there  should  be 
an  equity  in  the  value  of  the  collateral  sufficient  to  pay  for  the 
greatest  possible  amount  of  interest  due  during  the  extended  term 
of  life.  In  other  words,  the  selling  price  of  the  bond  should  be  suffi- 
ciently low  to  cover  unexpectedly  long  interest  payments.  Obviously 
the  net  return  on  such  a  bond  cannot  be  figured  from  the  bond 
tables.    It  is  the  province  of  the  actuary  to  determine  the  cost  to 


80      CLASSIFICATION  AND  DESCRIPTION  OF  BONDS 

return  a  given  approximate  yield,  or  the  approximate  yield  at  a 
given  cost. 

232.  _Cur  Trust  Certificates,  or  Notes,  on  the  one  hand,  and  Equip- 
ment Bonds,  or  Notes,  on  the  other,  are  the  two  common  forms  of 
,  securities  by  which  railroads  obtain  rolling  and  floating  stock  on 
I      collateral  credit. 
3,      4.       233.    The  older  form,  Car  Trust  Notes,  are  usually  certificates 
—=    issued  by  Oar  Trusts,  or  Equipment  associations  (that  built  or  pur- 
iovw-  chased  equipment  to  sell  to  railroads)   to  the  effect  that  a  certain 

*'-£■*•  «L»$*-  sum  is  due  the  holder  when  certain  rentals  are  paid  by  the  railroad. 
Formerly  the  lease  warrants  covering  the  rentals  were  the  collateral 
security  for  the  certificates.  Of  late  individual  warrants  for  the  in- 
stalments of  rent  have  been  deemed  superfluous,  since  specific  refer- 
ences to  the  disposition  of  the  rentals  are  in  the  contract  of  lease. 
i.QIs\iq  c\  flf_  234.  Equipment  Bonds  are  to  be  broadly  distinguished  from  Car 
tf'  Trust  Certificates  first  in  the  maker,  which  is  not  an  equipment  asso- 

'  ^  -^O?  ciation,  but  the  railroad  itself,  and  secondly  in  the  security,  which  is 
not  the  lease,  but  a  regular  contract  of  conditional  sale.  In  either 
type  of  security  title  remains  in  the  trustee  to  the  benefit  of  the  se- 
curity holders  until  the  railroad  has  made  all  lease  or  instalment 
payments. 

Further  comments  are  reserved  for  Chapter  XXTTI  on  Equipment 
Bonds. 

235.  Sinking  Fund  Bonds  are  those  for  which  the  mortgage  deed 
requires  that  a  stated  sum  shall  be  set  aside,  periodically,  out  of 
earnings  in  order  to  retire  the  bonds  from  year  to  year,  as  they 
mature. 

236.  The  propriety  of  sinking  funds  for  state  and  municipal 
loans  is  fully  discussed  in  the  proper  chapters.  From  the  days 
of  Albert  Gallatin  there  have  not  been  wanting  men  of  sufficient 
clarity  of  vision  in  financial  matters  to  realize  the  unnecessary  com- 
plexity and  waste  in  sinking  fund  accounts  and  the  simplicity  and 
economy  of  applying  a  surplusage  directly  to  the  cancellation  of 
debt.  But  it  is  only  in  recent  times  that  the  same  principle  has  ob- 
tained recognition  for  corporation  bonds. 

237.  Twenty  years  ago  sinking  funds  were  considered  a  usual  and 
proper  safeguard  of  railway  loans,  but  the  experience  of  the  lean 
years  following  the  panic  of  1893  destroyed  faith  in  their  efficacy, 
for  about  25  per  cent,  of  all  railway  obligations  so  secured,  defaulted. 
It  came  to  be  realized  that  sinking  fund  accounts  could  be  subject 
to  manipulative  tactics  which  would  render  them  a  source  of  ex- 


ACCORDING  TO  THE  SECURITY  FOR  THE  BONDS     87 


pense  and  loss  of  credit,  rather  than  of  income  and  confidence.  For 
instance,  where  earnings  did  not  admit  payments  to  the  sinking 
funds  (which  in  accounting  are  a  charge  prior  to  interest  payments) 
new  bonds  were  issued  to  raise  the  money  necessary  for  sinking  fund 
payments,  so  the  total  debt  was  increased  rather  than  decreased, 
with  consequent  loss  of  net  earning  power  and  credit.  Thus  it  was 
realized  that  the  best  reinforcement  of  an  obligation  was  obtained 
by  putting  the  surplusage  back  into  the  property,  and  by  refunding 
bond  issues  as  they  matured,  on  the  strength  of  an  increased  credit, 
and  therefore  at  a  lower  rate  of  interest. 

238.  It  is  evident,  however,  that  this  fiscal  policy  will  not  always 
be  best  for  small  companies,  or  for  companies  owning  properties 
which  must  be  depleted  to  produce  revenue.  It  is  imperative,  for  in- 
stance, that  the  outstanding  obligations  of  a  coal  company  should 
lessen,  as  the  supply  of  its  marketable  product  lessens.  Strongly 
safeguarded  sinking  funds,  therefore,  should  accumulate  to  discharge 
the  bonded  debt  when  due. 

239.  With  the  exception  of  telephones,  perhaps,  of  all  kinds  of 
property  commonly  bonded,  rolling  stock  depreciates  with  greatest 
certainty  and  rapidity.  After  fifteen  or  twenty  years  there  is  very 
little  life  left  in  it.  Yet  equipment  bonds  are  one  of  our  strongest 
securities.  Most  equipment  issues,  and  the  best  of  them,  have  no 
sinking  funds.  Their  principal  safety  lies  in  the  fact  that  the  debt 
is  paid  off  more  rapidly  than  the  cars  and  engines  wear  out.  Here  is 
the  best  exemplar  of  reinforced  security :  Serial  Repayment. 

But  in  small  companies,  and  in  those  subject  to  the  depletion  of 
their  material  assets,  if  there  is  not  serial  repayment,  then,  by  all 
means,  there  should  be  sinking  fund  accumulation. 

240.  The  premature  payment  of  funded  debt  may  oe  schematized 
as  follows: 


Amortization  < 


Serial 
Repayment 

Sinking  Fund 
Payment 


By  serial  bonds 

By  equal  annual  instalment  bonds 


By  accumulation 
of  cash 

By  investment 
of  cash 


r  Through  purchase  and  preserva- 
tion of  alien  bonds 

Through  purchase  and  preserva- 
tion of  own  other  issues 

Through  purchase  and  preserva- 
tion of  own  bonds  of  this  issue 

Through  purchase  and  cancella- 
tion of  own  bonds  of  this  issue 


There  are  advantages  and  disadvantages  in  each  of  these  disposi- 

Cash  accumulations,  even  when  restricted 


tions  of  the  sinking  fund 


88      CLASSIFICATION  AND  DESCRIPTION  OF  BONDS 

to  special  uses,  are  a  help  to  the  company's  credit  and  banking 
accommodations.  But  cash,  on  deposit,  is  at  best  accumulative  at 
the  rate  of  only  3  per  cent.,  whereas  cash  converted  into  investment 
will  yield  at  least  4  per  cent.,  and  perhaps  more.  This  disadvantage 
in  interest  rate  is  felt  by  the  company  more  than  by  the  bondholder, 
but  in  a  very  true  sense  that  which  is  detrimental  to  the  one  is 
detrimental  to  the  other. 

Cash  funds  are  not  only  liable  to  ultimate  misappropriation,  but 
to  temporary  and  expensive  misuse.  A  railroad  company,  now  in 
bankruptcy,  is  understood  to  have  loaned  interested  bankers  last  year 
several  hundred  thousand  dollars  that  belonged  to  a  subsidiary,  and 
then,  for  lack  of  cash,  was  obliged  to  hire  equipment.  By  with- 
drawing this  sum  and  using  it  as  the  nucleus  for  equipment  pur- 
chase, the  present  management  saves  this  year  some  fifty  thousand 

dollars. 

241.  Even  though  the  disposition  of  sinking  funds  by  investment 
yields  a  higher  return,  it  makes,  of  the  company,  a  financial  and 
investment  institution,  unless  the  terms  of  the  deed  of  trust  require 
of  the  trustee  a  supervision  more  than  usually  close.  The  company, 
as  such,  is  not  fitted  to  make  investments ;  if  it  purchases  for  sink- 
ing funds  the  bonds  of  other  companies,  its  natural  disability  is 
increased  by  its  possible  efforts  to  obtain  a  rate  of  return  equal  to 
that  it  would  have  obtained  if  it  purchased  its  own  bonds.  The 
company  is  more  conversant  with  the  investment  value  of  its  own 
obligations  than  it  can  possibly  be  with  that  of  the  obligations  of 
other  companies,  but  if  various  alien  securities  are  purchased  solely 
on  the  basis  of  their  investment  worth,  then  the  sinking  fund  has 
distributed  its  investment  risk.  Since  these  purchases,  and  their 
changing  value,  are  not  ordinarily  matters  of  public  knowledge, 
the  bondholder  has  no  means  of  knowing  to  what  extent  the  security 
for  his  bond  is  increasing  in  this  amortization  of  the  debt  by  proxy, 
as  it  were. 

242.  There  are  three  ways  in  which  a  company  may  invest  its 
sinking  funds  in  its  own  bonds.  It  may  purchase  and  keep  alive 
parts  of  its  other  issues,  or  of  parts  of  the  issues  being  amortized, 
or  it  may  purchase  and  cancel  parts  of  the  issue  being  amortized. 

To  purchase  parts  of  its  other  issues  will  increase  the  general 
equity  of  the  company  since  it  cannot  very  well  owe  itself,  and  in- 
vestment in  its  own  bonds  supposes  a  knowledge  of  the  securities 
purchased.    Otherwise  the  plan  has  little  to  recommend  it. 

To  purchase  and  keep  alive  in  the  sinking  fund  bonds  of  the  issue 


ACCORDING  TO  THE  SECURITY  FOR  THE  BONDS      89 

being  amortized  is  a  truer  reduction  of  the  loan,  for  these  bonds 
may  not  again  be  reissued. 

To  purchase  bonds  of  the  issue  and  cancel  them,  lessens,  as  the 
previous  plan  does  not,  the  fixed  charges  of  the  company,  but  since 
it  does  not  compound  the  moneys  applied  to  the  sinking  fund,  less 
bonds  will  be  thus  amortized  for  each  thousand  dollars  of  appropria- 
tion. 

243.  Appropriations  to  the  sinking  fund,  like  the  serial  repay- 
ment scheme  above,  may  be  in  equal  annual  payments  of  principal 
amounts,  or  the  payments  may  be  graduated  so  that  the  heaviest 
charge  for  payment  of  principal  may  not  come  at  the  beginning 
when,  theoretically,  the  company  is  not  so  well  situated  to  meet 
them  out  of  the  increased  earnings  due  to  the  expenditure  of  capital 
raised  by  the  bond  issue.  In  common  practice  this  difficulty  is  met 
by  increasing  gradually  the  percentage  of  net  earnings  that  apply 
to  the  fund;  or,  with  less  reference  to  earnings  and  more  to  mathe- 
matics, the  company  may  cumulate  predetermined  sums  so  that  as 
the  bonds  bought  for  the  fund  increase  the  interest,  payments  on 
account  of  the  principal  may  grow  smaller. 

244.  From  the  investor's  point  of  view  it  is  objectionable  that 
bonds  should  be  callable  for  the  sinking  fund  unless  at  a  consider- 
able premium  over  the  investment  value,  for  otherwise  the  fact  tends 
to  retard  the  natural  appreciation  of  the  security.  Sometimes  the 
trust  deed  stipulates  that  the  bonds  shall  be  bought  in  the  open 
market  when  tenders  are  made  at  some  reasonable  price.  This  helps 
to  maintain  the  price  and  the  market.  If  bonds  may  not  be  had 
at  the  upset  price,  then  the  trustee  may  be  empowered  to  invest 
the  fund  as  he  sees  fit,  within  certain  restrictions. 

245.  Lien  on  Sealty.  That  reinforcement  of  a  promise  to  j>_ay 
which  is  a  pledge  of  real  property  is  the  most  easily  understood  and 
enforced,  and,  all  things  considered,  is  the  most  satisfactory. 

246.  Although  Civil  Loans  are  very  largely  Debentures,  and  in 
Great  Britain  and  Canada  it  is  customary  to  call  municipal  loans 
Debentures,  nevertheless,  as  has  been  intimated,  Municipal  Mortgage 
Bonds  are  by  no  means  uncommon,  and  occasionally  are  classed  to- 
gether and  so  entitled.  The  classification,  however,  may  be  thought 
rather  academic,  for  the  bonds  spring  from  no  common  cause  and 
have  few  common  characteristics  except  the  mortgage  feature.  Mu- 
nicipal water  bonds  are  often  secured  by  a  mortgage  on  the  plant. 
In  giving  the  mortgage  perhaps  municipalities  are  influenced  by  the 
fact  that  private  water  companies  are  bonded,  and  in  taking  over 


90      CLASSIFICATION  AND  DESCRIPTION  OF  BONDS 

such  companies  it  is  natural  that  the  old  bonds  should  either  be 
guaranteed  or  assumed,  or  be  refunded  with  a  new  issue  of  munici- 
pal origin,  backed  by  pledge  of  the  plant.  It  will  be  found  that 
most  kinds  of  municipal  mortgage  bonds  are  secured  upon  property 
which  is  revenue-producing. 

247.  Real  Estate  Mortgage  Bonds,  as  a  title,  is  applicable  to 
several  distinct  bond  classes.  In  the  first  place  it  is  sometimes  used 
to  denote  all  issues  having  as  security  a  lien  on  real  estate.  In  this 
broad  extension  of  the  phrase  all  railroad  mortgage  bonds,  for  in- 
stance, come  under  the  classification  except,  perhaps,  a  few  that 
are  primarily  secured  by  a  lien  on  leaseholds.  Secondly,  it  is  com- 
monly used,  as  in  this  book,  of  that  class  of  bonds  issued  by  real 
estate  companies  which  is  secured  by  mortgages  on  real  estate. 
Or  again,  it  may  be  used  of  the  issues  of  any  corporation  that  are 
secured,  in  whole  or  in  part,  by  liens  on  the  company's  real  estate, 
rather  than  on  its  plant  and  equipment  as  a  whole.  The  classic  illus- 
tration of  Corporation  Real  Estate  Mortgage  Bonds  is  the 
Western  Union  Telegraph  Co.'s  Funding  and  Real  Estate  4|s  of 
1950. 

248.  Real  Estate  Bonds  is  a  common  title  for  Real  Estate  Mort- 
gage Bonds  issued  by  railroads  on  property  not  directly  used  in  the 
operation  of  the  road.  The  Terminal,  Dock,  and  Wharf  Bonds,  etc., 
which  are  mentioned  presently,  may  be  looked  upon  as  subdivisions 
of  the  class.  The  Charleston  Real  Estate  4  per  cent.  Land  Mort- 
gages of  the  Boston  and  Maine  were  an  excellent  example.  Real 
Estate  Bonds  is  also  an  abbreviation  for  Real  Estate  Company 
Bonds. 

249.  Land  Grant  Bonds  are  a  species  of  railroad  Real  Estate 
Bonds.  They  are  secured  by  liens  on  lands  granted  by  a  govern- 
ment. The  proceeds  from  the  sale  of  the  lands  to  settlers  establishes 
a  sinking  fund  from  which  to  retire  the  bonds.  The  Canadian  Pa- 
cific Land  Grant  Gold  3^s  are  the  leading  issue  of  this  class  now  out- 
standing in  America. 

250.  Farm  Mortgage  Bonds  were  a  type  in  great  vogue  in  the 
trans-Mississippi  plains,  two  or  three  generations  ago.  Themselves 
a  refinement  on  the  farm  mortgage,  they  later  became  commonly 
used  as  collateral  for  the  obligations  of  real  estate  brokers  and 
promoters.  A  few  successive  seasons  of  drought  and  hot  winds  in 
the  eighties  drove  the  farmers  further  west.  Western  real  estate 
companies  were  driven  to  the  wall ;  their  guaranties  were  worthless, 
and  unsecured  bonds  were  unsatisfied.     Eastern  holders  of  mort- 


ACCORDING  TO  THE  SECURITY  FOR  THE  BONDS     91 

gages   found   themselves   owners   of   unproductive   property.     The 
savings  banks  of  a  New  England  State  were  crippled. 

The  collapse  of  Western  plains  land  values  was  a  blow  to  the 
popularity  of  farm  mortgages  and  farm  mortgage  bonds  from  which 
they  never  recovered.  Yet  there  is  no  inherent  weakness  in  farm 
mortgages  as  security  for  bonds.  When  investments  in  either  are 
made  at  first  hand  by  competent  buyers,  such  as  insurance  com- 
panies, farm  mortgages  are  excellent  security.  But  so  little  technical 
training  and  experience  is  required  to  do  a  farm  or  general  real 
estate  mortgage  bond  business,  that  many  may  be  trusted  to  be  in 
the  field  who  are  without  scruple  and  experience.  Like  irrigation 
bonds,  these  securities  should  be  bought  only  of  houses  with  acknowl- 
edged standing  in  the  special  field. 

251.  Mortgage  Incidence.  The  titles  to  several  kinds  of  bonds 
arise  from  the  fact  that  issues  may  be  secured  by  mortgages  on  only 
a  part  of  the  company's  property.  They  are  entitled  according  to 
the  character  of  the  property  mortgaged. 

It  is  natural  that  most  of  these  titles  concern  railroad  bonds  since 
railroads  usually  embrace,  in  one  system,  property  spread  over 
several  states. 

252.  Divisional  Bonds  are  secured  by  mortgage  on  railroad  divi- 
sions. The  division  originally  may  have  been  an  independent  com- 
pany, and  as  such  may  have  issued  the  bonds.  In  case  of  merger, 
the  issue  is  both  Assumed  and  Divisional.  The  purer  type  is  that 
issued  by  the  system  itself  and  secured  on  a  section  of  the  road 
which  the  railroad,  as  an  operating  company,  calls  a  division. 

It  will  be  well  to  limit  the  term  Divisional  to  these  two  forms. 
However,  if  the  division  maintains  a  separate  corporate  existence, 
but  is  controlled  by  the  system,  and  its  issue  or  issues  are  guaran- 
teed by  the  system,  the  bonds  may  be  called  loosely  Divisional  Bonds. 
If  the  division  has  two  issues,  whether  they  are  guaranteed  or  not, 
the  prior  Divisional  Bonds  may  even  be  underlying  the  system's  con- 
solidated issue,  for  although  the  parent  corporation  cannot  give  a 
mortgage  on  real  property  that  does  not  belong  to  it  as  a  corpora- 
tion, yet  it  may  place  the  junior  Divisional  Bonds  as  collateral 
behind  its  consolidated  issue. 

253.  Extension  Bonds  are,  in  essence,  divisional  bonds  of  the  pure 
type,  but  the  mortgage  incidence  may  be  such  as  not  to  coincide  with 
operating  divisions.  Loosely,  Extension  Bonds  is  simply  the  more 
descriptive  term  when  the  line  pledged  is  a  continuation  or  exten- 
sion of  the  system  into  new  territory.    That  is,  the  bonds  are  secured 


92      CLASSIFICATION  AND  DESCRIPTION  OF  BONDS 

by  mortgage  on  the  extension.  They  may  be  additionally  secured  by 
a  junior  lien  on  the  older  properties  of  the  company.  If  a  portion 
of  the  issue  is  held  in  escrow  to  retire  the  mortgage  bonds  of 
the  old  divisions  the  new  issue  is  of  Refunding  and  Extension 
Bonds. 

Divisional  and  Extension  Bonds  that  are  not  direct  obligations  of 
the  system,  are  safe  investments  only  when  the  mortgaged  line  is  es- 
sential to  the  operation  of  through  traffic,  as  in  the  case  of  a  Main 
Line  issue,  or  else  when  it  originates  an  assured  amount  of  traffic  the 
net  earnings  from  which  will  always  exceed  the  requirements  of  the 
divisional  or  extension  bond  issue. 

Extension  Bonds  should  not  be  confused  with  Extended 
Bonds. 

254.  Kindred  to  Extension  Bonds,  and  of  the  Divisional  type, 
are  Purchased  Line  Bonds,  although  in  this  case  the  implication 
is  that  the  division  or  road  acquired  has  been  constructed  and  pre- 
viously operated  as  an  independent  company.  The  bonds  will  be 
secured  by  mortgage  on  the  line  or  lines  purchased. 

Purchased  Line  Bonds,  in  turn,  must  be  distinguished  from  Pur- 
chase  Money  Bonds. 

255.  The  following  five  kinds  of  mortgage  issues  differ  only  in 
the  character  of  the  property  for  which  the  money  was  raised, 
directly  or  indirectly.  Separate  companies  may  have  been  incorpo- 
rated for  the  purpose  of  holding  title  and  of  issuing  the  securities. 
One  or  the  other  of  two  causes  are  generally  at  work  when  these  sub- 
sidiary companies  are  formed : 

I.  It  may  be  desired  that  the  property  come  into  the  hands  of  the 
railroad  already  mortgaged,  so  that  the  cost  of  the  property  may  be 
defrayed  by  a  bond  issue  which  can  be  sold  on  the  advantageous 
terms  that  a  straight,  closed  first  mortgage  will  bring.  If  there  is 
a  blanket  mortgage  of  the  railroad  outstanding  which  becomes  a 
lien  on  "  all  property  subsequently  acquired  "  the  funds  raised  to 
acquire  this  property  will,  perhaps,  be  obtained  on  less  favorable 
terms,  under  the  blanket  mortgage,  or  perhaps  that  issue  is  all  out- 
standing so  that  no  funds  can  be  raised  from  it. 

II.  The  property  acquired  and  the  works  constructed  may  be  for 
the  joint  use  and  advantage  of  several  railroads.  That  all  may  have 
an  evident  pari  passu  interest  and  proprietorship  in  the  property, 
part  ownership  and  control  of  it  is  best  obtained  by  the  ownership 
of  part  of  the  stock  of  the  new  company  formed  to  own  the  property. 
The  bonds  of  this  new  company  will  be  its  direct  obligation,  further 


ACCORDING  TO  THE  SECURITY  FOR  THE  BONDS     93 

secured  by  mortgage  on  the  property,  and  possibly  also  by  joint  or 
joint  and  several  guaranty  as  well. 

256.  Bridge  Bonds  are  not  likely  to  be  issued  for  construction 
purposes  unless  the  engineering  is  on  a  scale  to  require  separate 
financing.  The  Kansas  City,  Fort  Scott,  and  Memphis  Railroad  has 
guaranteed  the  $3,000,000  First  mortgage  issue  of  its  subsidiary,  the 
Kansas  City  and  Memphis  Railway  and  Bridge  Company  for  the 
bridge  thrown  across  the  Mississippi  River  at  Memphis.  To  save 
the  expense  of  several  structures  railroads  often  unite  in  the  use  of 
a  single  bridge,  which  may  best  be  financed  by  a  separate  company 
with  bridge  bonds. 

257.  Ferry  Bonds  are  seldom  the  result  of  community  of  interest , 
but  rather  of  the  first  cause  mentioned  above:  namely,  a  desire  to 
bring  the  property  into  the  control  of  the  railroad  with  as  small  an 
equity  as  possible  for  the  benefit  of  the  blanket  mortgage  bond- 
holders. For  the  bonds  to  be  safe,  apart  from  the  guaranty  of  a 
trustworthy  company,  it  must  be  established  that  the  need  of  a 
ferry  will  outlast  the  life  of  the  bonds. 

258.  Dock  and  Wharf  Bonds  share  the  investment  characteristics 
of  both  Ferry  and  Terminal  Bonds,  with  distinction  only  as  to  the 
nature  of  the  property  pledged.  Incorporation  of  a  separate  dock 
or  wharf  company  may  be  the  result  of  a  community  of  railroad  in- 
terests, or  may  be  an  evasion  of  the  "  after  acquired  property 
clause." 

259.  Terminal  Bonds,  also,  are  usually  the  result  of  a  community 
of  railroad  interests.  One  of  the  most  difficult  problems  in  railway 
transportation  is  to  obtain  adequate  terminal  facilities  in  proper 
situations  at  a  cost  commensurate  with  the  traffic  return.  In  many 
of  the  large  cities  "  Union  Depots  "  solve  this  problem.  The  ex- 
pense incurred  and  the  benefits  accruing  are  shared  by  the  railroads 
that  are  parties  to  the  undertaking.  A  common  arrangement  is  the 
formation  of  a  terminal  company  to  be  owned  solely  by  the  interested 
railroads.  The  terminal  bonds  of  this  company  will  be  secured  on 
the  real  estate,  trackage,  and  other  property  of  the  company  and 
will  be  jointly  guaranteed  by  the  railroads.  Illustrations  are  the 
Boston  Terminal  Company  3|s  already  mentioned,  and  the  Terminal 
Railroad  Association  of  St.  Louis  4s.  The  Washington  Terminal 
Company  3|s  and  4s  are  guaranteed  jointly  and  severally  by  the 
two  railroads  that  own  the  company. 

A  weaker  form  of  Terminal  Company  bond  is  that  secured  on  ter- 
minal property  not  owned  or  controlled  by  the  lessee  railroads.    A 


94      CLASSIFICATION  AND  DESCRIPTION  OF  BONDS 

bond  issued  under  such  circumstances  is  not  likely  to  be  guaran- 
teed. The  Chicago  Terminal  Transfer  4s  issued  in  1897  are  of  this 
kind. 

Terminal  bonds  may  be  the  obligation  of  a  single  railroad,  and 
secured  by  mortgage  on  one  or  more  terminals,  as  the  Chicago,  Mil- 
waukee, and  St.  Paul  Terminal  5s  of  1914,  or  on  terminals  and 
trackage,  but  if  the  trackage  is  of  considerable  value  in  relation  to 
the  whole,  the  word  Terminal  may  not  appear  in  the  title. 

Terminal  bonds  that  are  the  direct  obligations  of  one  or  more  in- 
terested railroads  are  a  good  class  of  investment  paper,  for  they  are 
really  underlying  liens.1  But  the  default  on  the  Chicago  Terminal 
Transfer  4s  calls  attention  to  the  fact  that  terminals,  in  them- 
selves, rarely  pay  the  cost  of  construction,  and  the  investment  value 
of  their  securities  depends  on  their  relation  to  an  entire  system. 
So  considered,  terminal  improvements  pay,  but  only  when  the  ex- 
penditure is  not  a  capital  burden  out  of  proportion  to  the  size  of 
the  road  or  roads  that  undertake  them. 

260.  Mortgage  Priority.  Many  bond  titles  have  their  origin  in 
the  standing  of  the  mortgage  that  reinforces  the  obligation.  At 
times  these  titles  are  misleading.  For  instance,  the  Chicago  and 
Alton  Refunding  3s  of  1949  are  a  first  mortgage  on  596  miles  of 
track.  The  Chicago  and  Alton  First  Lien  3|s  of  1950  are  a  second 
mortgage  on  this  same  track  and  a  first  mortgage  on  less  than  54 
miles. 

Morfaflffp.  priority  is  a  matter  of  gravest  importance,  even  if  a 
property  is  not  subjected  to  foreclosure,  because  reorganizations,  to 
gain  acceptance  by  the  creditors,  must  recognize  the  relative  strength 
of  the  several  liens  and  make  readjustment  of  the  capitalization  and 
the  debt,  on  that  basis. 

Priority  is  entirely  a  relative  matter  and  there  are  several  terms 
which  properly  convey  the  idea  of  the  relative  strength  or  weakness 
of  the  lien. 

261.  Prior  Lien  Bonds  are  simply  bonds  which  are  "  closer  to  the 
ground,"  i.e.  mortgage  obligations  with  rights  on  the  property  held  in 
trust  that  are  prior  to  some  other  rights.  It  is  not  unusual  to  hear 
the  custom  deprecated,  as  wilfully  misleading,  of  calling  loans  Prior 
Lien  that  are  not  a  first  mortgage.  This  criticism  is  hardly  de- 
fensible. Priority  does  not  suggest  primacy,  but  merely  precedence; 
it    is    not    an    absolute    but    a    relative    term.      However,    the 

1  The  Portland  and  Rochester  Terminal  4s  are  mere  debentures, — assumed  by 
the  Boston  and  Maine. 


ACCORDING  TO  THE  SECURITY  FOR  THE  BONDS      95 

use  of  the  term  may  be  overdone,  as  in  case  of  the  Erie  First 
Consolidated  Prior  Lien  4s,  which  are  a  sixth  mortgage  on  the 
line. 

262.  Underlying  Bonds  is  a  term  that  should  be  practically  syn- 
onymous with  Prior  Lien  Bonds,  for  it  merely  implies  that  there  are 
Overlying  Bonds.  But  perhaps  in  practice  Underlying  Bonds  are 
more  generally  secured  by  first  mortgage  or  its  equivalent.  Just 
as  Junior  Lien  is  the  antonym  of  Prior  Lien,  Overlying  is  an 
antonym  for  Underlying. 

263.  Senior  Issues  and  Junior  Issues  make  another  set  of  com- 
plementary terms;  but  these  differ  from  the  foregoing  since  they 
extend  over  not  only  the  mortgage  obligations,  but  the  debentures. 
Of  the  two  expressions  "  Junior  Issues  "  is  the  more  common.  The 
adjective  "  Junior  "  reverts  to  the  security  also  and  we  have  "  Junior 
Liens."  Of  course  the  Senior  are  the  Prior  Issues  and  among  mort- 
gages the  Junior  are  Overlying  Issues. 

264.  First  Mortgage  Bonds  speak  for  themselves.  They  are 
secured  by  a  first  mortgage  on  all  or  part  of  a  property.  In  rail- 
road companies  that  part  of  its  entire  property  which  yields  a 
first  lien  to  any  one  issue  is  likely  to  be  very  small,  for  divisional, 
extension,  and  subsidiary  company  liens  are  usually  attached  to 
most  of  the  line.  However,  the  tendency  in  corporate  finance  is 
to  reduce  the  number  and  simplify  the  character  of  funded  obliga- 
tions. Therefore  many  issues  that  are  not  now  very  "  close  to  the 
ground "  will  become  absolute  First  Mortgages  in  future  years, 
when  divisional  mortgages  mature. 

265.  The  term  first  mortgage  may  be  used  (and  sometimes  is) 
of  a  lien  on  personal  property:  on  chattels  and  rights  of  one  kind 
or  another.  First  Mortgages  recorded  on  leaseholds  of  realty  and 
rolling  stock  are  not  at  all  uncommon.  Investors  have  difficulty 
in  appreciating  that  there  is  no  innate  legal  superiority  in  a  realty 
mortgage.  A  recorded  mortgage  secured  by  the  leasehold  rights  on 
a  piece  of  property  is  prior  to  a  subsequently  recorded  mortgage 
on  the  fee. 

266.  Refunding  First  Mortgage  Bonds  is  given  separate  men- 
tion that  a  careful  distinction  will  be  made  between  these  and 
First  Refunding  Mortgage  Bonds.  The  former  is  what  the  words 
imply:  an  issue  refunding  a  First  Mortgage  Bond.  The  latter  is 
the  first  issue  (in  point  of  time)  which  the  company  has  floated  to 
refund  old  bonds.  Obviously,  the  title  is  misleading  and  unneces- 
sary.   One  is  justified  in  believing  it  is  sometimes  used  to  give  the 


9G      CLASSIFICATION  AND  DESCKIPTION  OF  BONDS 

impression  that  the  bonds  referred  to  are  secured  in  part  by  a  first 
mortgage. 

267.  First  and  Refunding  Mortgage  Bond*  admits  of  no  such 
equivocation.  What  assurance  of  security  the  title  gives  is  in  the 
First  which  declares  the  bonds  are  secured  by  a  first  mortgage. 
The  First  element  in  the  Missouri  Pacific  First  and  Refunding  5s  is 
a  first  lien  on  165  miles.  The  Refunding  element  represents  a  pro- 
spective betterment  of  the  present  position  of  the  obligation  as 
secured  by  second,  third,  fourth,  and  fifth  mortgages  in  3,616 
miles. 

268.  First  and  Refunding  Bonds  are  the  most  important  class 
of  railroad  issues  with  which  bankers  now  have  to  deal.  They 
are  the  soundest  means  of  financing,  and  the  commonest  expres- 
sion in  securities,  of  the  present  tendency  to  gather  up  in  one 
general  mortgage  all  the  miscellaneous  debts  of  the  corporation. 

Let  us  suppose  a  railroad  has  a  closed  Consolidated  Lien  of 
$25,000,000  covering  500  miles  of  track,  and  has  just  built  100 
miles  of  track  for  which  it  must  now  be  reimbursed  by  a  bond  issue 
mortgaging  this  new  track.  If  the  road  purposes  to  issue  a  new 
first  mortgage  bond  in  the  sum  of  $5,000,000  to  cover  the  100  miles 
of  new  construction  the  bankers  may  advise,  instead,  an  issue  of 
$40,000,000  authorized,  First  and  Refunding  Bonds,  of  which  $25,- 
000,000  will  be  reserved  to  retire  the  Consolidated  Lien,  $5,000,000 
to  pay  for  and  be  a  first  lien  on  the  new  100  miles  and  $10,000,000 
will  be  reserved  for  extensions  and  improvements  under  such  re- 
strictions as  will  protect  the  issue. 

269.  Open  First  and  Refunding  issues  along  lines  similar  to 
these  are  financing  the  needs  of  the  Rock  Island,  the  Delaware  and 
Hudson,  the  Denver  and  Rio  Grande,  the  Missouri,  Kansas,  and 
Texas,  the  Missouri  Pacific,  the  Wisconsin  Central,  and  about  two 
dozen  more  of  our  larger  railroad  systems.  It  will  be  seen,  there- 
fore, that  fifty  years  hence  American  railways  ought  to  be  bene- 
fiting by  a  much  simpler  scheme  of  funded  debts. 

A  confusion  of  bond  terms  similar  to  that  mentioned  above, 
exists  regarding  other  issues. 

270.  Consolidated  Mortgage  Bonds,  properly,  are  bonds  secured 
by  a  mortgage  on  properties  that  have  been  consolidated.  There 
may  be  underlying  issues  on  any  of  the  properties.  Another  less 
exact  and  legitimate  use  of  the  title  is  for  issues  that  ultimately 
consolidate,  by  refunding,  several  prior  mortgage  issues  on  one 
property. 


ACCORDING  TO  THE  SECURITY  FOR  THE  BONDS      97 

271.  Consolidated  First  Mortgage  Bonds  should  signify  an  issue 
secured  by  a  first  mortgage  on  consolidated  properties. 

272.  First  and  Consolidated  Mortgage  Bonds  should  signify  a 
consolidated  issue  secured  by  a  first  mortgage  on  part  of  the 
consolidated  properties.  It  is  inexactly  used  as  synonymous  with 
First  and  Refunding,  First  and  General,  and  First  and  Unified 
issues. 

273.  First  Consolidated  Mortgage  Bonds  should  signify  the  first 
consolidated  issue  that  the  company  has  floated. 

274.  General  Mortgage  Bonds  is  the  most  honest  expression  for 
what  most  recent  railroad  issues  are :  viz.  loans  secured  by  a  general 
or  blanket  mortgage  on  most,  if  not  all,  the  railroad  property,  but 
subject  to  the  prior  liens  which  they  ultimately  refund. 

275.  General  First  Mortgage  Bowels  as  a  title  is  a  misnomer. 
If  it  is  a  general  mortgage  it  is  not  a  first  mortgage.  The  title  is 
sometimes  used  when  the  amount  of  the  underlying  bonds  is  small 
and  bonds  of  the  general  issue  have  been  reserved  in  the  hands 
of  the  trustee  to  retire  them.  But  the  proper  title  for  this  class 
is  General  and  First  Mortgage  Bonds,  or  First  Lien  and  General 
Mortgage  Bonds.  __ 

276.  First  General  Mortgage  Bonds  is,  by  interpretation,  the  first 
issue  of  General  Mortgage  Bonds.  Since  a  second  general  issue  is 
not  likely,  this  is  another  of  the  equivocal  titles. 

277.  Unifying  Mortgage  Bonds,  as  a  title,  with  the  usual 
derivatives,  is  virtually  synonymous  with  Consolidated,  or  with 
General  Mortgage  Bonds.  All  three  classes  serve,  in  process  of 
time,  to  simplify,  in  one  general  obligation  and  under  one  blanket 
mortgage,  the  miscellaneous  lien-secured  obligations  of  the  com- 
pany. That  there  may  be  no  necessity  in  the  near  future  of  re- 
peating the  generalization  of  funded  debt,  bonds  are  usually  re- 
served to  pay  for  all  improvements,  extensions,  etc.,  which  are  likely 
to  be  made  for  years  to  come.  The  issue,  therefore,  consolidates, 
unifies,  or  generalizes  not  only  past,  but  also  future  capital  re- 
quirements. 

278.  Although  Income  Bonds,  by  nature,  are  usually  without 
lien  security  and  interest  is  dependent  entirely  upon  earnings, 
nevertheless  some  issues  have  property  claim,  in  default  of  princi- 
pal at  maturity.    Hence  arise  Mortgage  Income  Bonds. 

279.  Mortgage  priority  is  clearly  defined  in  Second  and  Third 
Mortgage  Bonds.  Although  the  second  or  third  mortgage  issue 
of  one  company  may  be  superior  to  the  first  mortgage  issue  of 


°i. 


98      CLASSIFICATION  AND  DESCRIPTION  OF  BONDS 

another,  and  although  the  second  or  third  divisional  mortgage  of 
one  company  may  be  superior  to  the  first  mortgage  on  another 
division  of  the  same  company,  nevertheless  the  general  order  of 
preference  on  a  given  property,  in  default  or  liquidation,  is  the 
numerical  order  indicated  in  the  title. 

280.  But  the  prospective  purchaser  of  a  bond  to  be  bought  on  the 
basis  of  its  closeness  to  the  ground  should  remember  two  things: 
a  general  claim  on  the  entire  assets  of  a  company  will  sometimes 
obtain  readier  recognition  than  a  first  claim  on  minor  assets  which 
are  of  themselves  insufficient  to  satisfy  that  claim;  and  secondly, 
it  is  seldom  good  business  to  satisfy  entirely  the  owners  of  the 
first  mortgage  bonds  at  the  expense  of  the  owners  of  the  junior 
issues. 

281.  The  extent  to  which  the  theoretical  and  legal  priority  will 
be  satisfied  depends  very  largely  on  the  nature  of  the  property. 
If  it  is  convertible  without  too  great  sacrifice  of  its  intrinsic  value, 
— if  for  instance  it  is  marketable  real  estate, — then  the  only  hope 
for  holders  of  junior  mortgage  bonds  is  that  the  property  will  real- 
ize a  sum  sufficiently  in  excess  of  the  senior  claim  to  satisfy  them. 

282.  But  it  is  usually  the  case  that  the  property  has  value  chiefly 
in  connection  with  the  purposes  and  business  of  the  company 
pledging  it.  A  railroad  right  of  way  is  of  little  value  except  for 
transportation  service;  rails  as  scrap-iron,  and  ties  as  lumber  are 
almost  worthless.  Old  freight  cars  are  burned  up.  It  doesn't 
pay  to  dismantle  them  for  kindling  wood.  At  foreclosure  sale  a 
railroad  property  must  go  to  those  who  can  run  railroads.  In- 
vestors cannot  run  railroads.  Hence  the  necessity  for  comity  among 
creditors  and  a  reasonable  compromise,  even  with  stockholders. 

The  Refunding,  General,  and  Consolidation  Mortgage  Bonds 
just  discussed,  are,  when  issued,  usually  Second  or  Third  Mortgage 
Bonds  on  the  major  part  of  the  property. 

283.  Second  Refunding,  Second  Consolidated,  and  Second  Gen- 
eral Mortgage  Bonds,  each  refer  to  the  second  issue  of  their  kind 
by  the  one  company.  The  need  for  these  Seconds  arises  when  ample 
provision  for  extensions  and  betterments  was  not  made  in  the 
provisions  of  the  First  Trust  deed,  and  the  Seconds  will  probably 
bear  the  same  refunding  relation  of  successorship  and  perform  the 
same  function  as  reserve  funds,  that  the  First  Refunding,  Con- 
solidated, or  General  Bond  bore  to  the  underlying  divisional  liens. 
As  yet  this  class  is  very  rare. 

284.  Improvement   Mortgage   Bonds   are   of   the   same   general 


ACCORDING  TO  THE  SECURITY  FOR  THE  BONDS      99 

nature  as  the  bonds  mentioned  immediately  above:  they  are  both 
refunding  and  extension  bonds.  An  issue  is  more  likely  to  be 
entitled  Extension  than  Improvement,  when  the  chief  reinforce- 
ment of  the  obligation  is  a  mortgage  on  the  newly-constructed  or 
acquired  property. 

285.  Improvement  Mortgage  Bonds  should  be  distinguished  from 
the  municipal  debentures  called  Improvement  Bonds,  issued  for 
Public  Improvement  or  specifically  for  Street  Improvement. 

286.  Debenture  Mortgage  Bonds  is  a  hybrid  product,  in  essen- 
tials a  mere  promise  to  pay,  but  nominally  secured  by  a  junior  lien 
on  property  of  comparatively  small  value. 

287.  Mortgage  Debentures  as  synonymous  with  Mortgage  Bonds 
is  a  perfectly  logical  title  in  those  countries  which  use  the  word 
debenture  as  practically  synonymous  with  bonds  in  general,  rather 
than  with  unsecured  notes  in  particular. 


CHAPTER  X 

THE    CLASSIFICATION    AND    DESCRIPTION    OF    BONDS: 

ACCORDING  TO  THE  PURPOSE  OR  FUNCTION 

OF  THE   ISSUE 

288.  The  third  scheme  of  classification  is  according  to  the  pur- 
pose for  which  the  bonds  were  issued, — as  expressed  in  the  title 
of  the  bond.  The  detailed  treatment  accorded  municipal  issues 
and  other  civil  loans,  in  Part  II,  makes  it  unnecessary  to  mention 
here  more  than  a  few  issues  of  the  municipal  type.  Bonds  of  this 
third  class  are  noted  most  conveniently  in  alphabetical  order. 

289.  Anticipation  Tax  Warrants  is  one  of  the  many  titles  that 
is  practically  synonymous  with  Revenue  Bonds,  which  see. 

290.  Bonus  Bonds  is  a  frank  old-time  title  for  securities  issued 
by  private  corporations,  as  Land  Grant  Bonds  frequently  were,  in 
payment  for  services  rendered  by  promoters,  et  al.,  or  to  raise  money 
for  that  payment ;  and  by  municipalities,  as  in  the  more  specific  case 
of  Railroad  Aid  Bonds,  to  bring  a  railroad  or  manufacturing  con- 
cern to  a  town.  Subsidy  Bonds  is  a  more  euphemistic  expression 
than  Bonus  Bonds  for  the  same  general  class  of  issues,  when  the 
proceeds  reimburse  a  company  for  public  service  like  the  trans- 
portation of  mails  by  steamships.  Bonus  Bonds  of  private  cor- 
porations are  looked  upon  with  disapproval  when  they  do  not 
immediately  represent  a  profit-bearing  outlay,  and  may  not  increase 
the  value  of  the  property  on  which  they  are  secured.  Perhaps 
municipal  Bonus  Bonds  in  general  are  more  frequently  open  to 
charges  of  invalidity  than  Railroad  Aid  Bonds  in  particular. 
(See  Founders'  Bonds  and  Purchase  Money  Bonds.) 

291.  Charter  Bonds  are  United  States  bonds  purchased  by  a 
National  Bank  at  the  time  of  its  incorporation,  and  deposited  with 
the  Treasurer  of  the  United  States  that  it  may  receive  a  federa1 
charter  to  do  business. 

292.  Construction  Bonds  is  a  term  loosely  applied  to  issuer 
secured  by  property  and  plants  in  course  of  construction,  before 
the  company  that  issues  them  has  an  earning  power  of  record. 
The  term  is  applied  with  most   force  when  it  is  the  intention 

100 


ACCORDING  TO  THE  PURPOSE  OF  THE  ISSUE       101 

to  refund  the  issue  with  a  more  permanent  mortgage  bond, 
either  of  new  creation  or  of  a  general  issue  part  of  which 
is  now  in  escrow  for  this  purpose.  Having  reference  to  the  char- 
acter of  the  obligor,  the  bonds  may  be  floated  by  a  construction  com- 
pany, in  anticipation  of  instalment  payments  on  the  plant  or 
building.  In  this  case  they  are  probably  serial  notes,  and  like 
mechanics'  liens,  a  charge  on  the  plant  prior  to  a  regular  first 
mortgage. 

293.  Continued  Bonds  is  the  variant  for  Extended  Bonds  and 
of  less  common  use.  In  these  the  contract  for  payment  has,  by 
mutual  agreement,  been  extended.  The  object  on  the  part  of  the 
company  may  be  to  await  a  more  propitious  time  for  a  new  flota- 
tion. The  fact  of  extension  with  any  new  terms,  such  as  increased, 
or  possibly  reduced,  interest,  will  be  stamped  or  printed  on  the  old 
bonds.  The  practice  is  steadily  growing  of  extending  rather  than 
refunding  issues,  as  a  matter  of  mere  financial  expediency.  It  is 
thought  that  a  larger  proportion  of  the  holders  of  the  old  bonds 
will  take  advantage  of  the  "  privilege "  of  extending  their  loan 
than  would  be  the  case  if  they  were  called  upon  to  cancel  their  loan 
and  reinvest  on  the  same  terms.  New  certificates,  even,  may  be 
issued,  and  nothing  of  the  old  issue  be  left  but  the  corpus  of  the 
old  mortgage  and  the  time-honored  and  familiar  title. 

294.  Delinquent  Tax  Certificates,  are  of  the  municipal  mort- 
gage type.  They  are  a  first  lien  on  land  which  has  been  sold  in 
settlement  of  an  arrearage  of  taxes.  But  since  the  former  owner 
has  the  privilege  of  redeeming  the  property  within  a  stated  number 
of  years,  and  since  disputes  may  arise  concerning  the  regularity  of 
the  sale,  these  certificates  are  more  a  speculation  than  an  invest- 
ment. 

295.  Drainage  Bonds,  as  a  distinct,  quasi-municipal  class,  we 
treat  in  Chapter  XXXIII,  under  Reclamation  Issues,  but  direct  mu- 
nicipal obligations  are  often  so  entitled,  when  issued  for  drainage 
purposes. 

296.  Founders'  Bonds  (an  English  expression)  may  serve  the 
same  purpose  as  Bonus  Bonds  in  corporation  finance :  to  reimburse 
those  who  have  undertaken  the  promotion  of  an  enterprise.  But 
again  the  purpose  may  be  quite  the  other  extreme:  to  pay  the 
proprietor  or  founder  for  his  interest  in  the  company.  The  United 
States  Steel  Corporation  First  Collateral  Trust  5s,  issued  in  1901, 
are  in  large  part  Founders'  Bonds,  for  they  were  paid  to  Andrew 
Carnegie  (cf.  Purchase  Money  Bonds). 


102    CLASSIFICATION  AND  DESCRIPTION  OF  BONDS 

297.  Funding  Bonds  represent  the  unification  or  consolidation 
of  unfunded  debt,  of  various  informal  notes,  scrip,  and  other  forms 
of  floating  indebtedness.  Whether  the  obligations  are  of  munici- 
palities or  private  corporations,  a  floating  debt  has  served  its  useful- 
ness when  it  is  found  that  the  sum  cannot  be  extinguished  out  of 
current  revenues,  and  the  bond  market  is  favorable  to  flotations,  for 
then  a  regular  long  term  funded  issue  can  be  put  out  at  a  lower 
rate  of  interest  than  these  less  permanent  and  perhaps  less  well- 
secured  certificates  of  indebtedness.  Funding  Bonds  should  not 
be  confused  with  Refunding  Bonds. 

298.  Improvement  Bonds,  it  has  already  been  said,  are  quite 
distinct  from  Improvement  Mortgage  Bonds.  The  former  are  mu- 
nicipal debentures  issued  for  any  form  of  public  improvement. 
They  are  sometimes  special  assessment  bonds,  and  therefore  may  or 
may  not  be  direct  obligations  of  a  municipal  corporation  proper. 

299.  For  Interim  Certificates  see  Temporary  Bonds. 

300.  Judgment  Bands  are  another  form  of  municipal  debenture 
that  share  in  the  ill-favor  of  Special  Assessment  Bonds.  This  is 
because  they  are  the  product  of  litigation,  usually  respecting  the 
validity  of  a  debt.  But  if  the  municipality  is  able  to  pay,  and  the 
judgment  has  been  obtained  without  fraud,  the  obligation  should 
prove  a  safe  investment. 

301.  For  Provisional  Certificates  see  Temporary  Bonds. 

302.  Purchase  Money  Bonds  perform  the  same  function  as 
Founders'  Bonds:  they  are  issued  in  full  or  part  payment  for  a 
property  or  company.  When  for  a  property,  it  is  probable  they 
will  be  a  lien  on  that  property;  when  for  a  company  it  is  probable 
that  the  stock  will  be  pledged  as  security  for  the  bonds,  that  in 
case  the  interest  is  not  met,  the  company  may  revert  to  its  former 
owners. 

303.  For  Railroad  Aid  Bonds  see  the  Index. 

304.  Redemption  Bonds  are  equivalent  to  Refunding  Bonds;  but 
a  nice  sense  of  word  values  might  suggest  the  term  Redemption  for 
new  issues  that  succeed  called  issues,  and  Refunding  for  issues  that 
succeed  matured  issues.  There  is  no  connection  between  Redemp- 
tion Bonds  and  Redeemable  Bonds. 

305.  Renewal  Bonds  are  virtually  Extended  Bonds,  but  the  title 
may  be  used  for  Refunding  Bonds. 

306.  Revenue  Bonds,  or  Notes,  provide  municipalities  with  cur- 
rent funds  to  supply  their  needs  until  taxes  or  other  income  is 
collectible.     Tax  Relief  Bonds  is  another  title  for  the  same  class. 


ACCORDING  TO  THE  PURPOSE  OF  THE  ISSUE       103 

Similarly  Arrearage  Bonds  take  care  of  deficits  caused  by  tardi- 
ness in  payments  of  taxes  due. 

307.  School  Bonds  are  usually  emitted  for  the  purchase,  con- 
struction, and  equipment  of  school  property.  Their  standing  in 
the  investment  world  is  somewhat  better,  perhaps,  than  any  other 
class  of  municipals,  except  water  bonds,  for,  although  the  object 
for  which  they  are  put  forth  is  not  revenue-producing,  yet  they 
represent,  in  the  eyes  of  a  community,  the  noblest  purpose  for 
which  it  can  pledge  its  good  faith. 

308.  Sewer  Bonds  may  be  cited  as  another  class  of  municipals 
worthy  of  mention, — these  in  illustration  particularly  of  the  utter 
impossibility  of  cataloguing  all  bond  titles.  Among  the  subdivisions 
of  sewer  bonds  one  meets  are  Sewer  Trunk,  and  Intercepting  Sewer 
Bonds.  There  is  little  difference  in  legal  standing  between  these 
many  municipal  issues,  providing  they  are  direct  obligations  of 
municipalities  proper,  and  are  payable  out  of  unlimited  taxes 
levied  on  all  the  property. 

309.  Subsidy  Bonds.     See  Bonus  Bonds. 

310.  Tax  Arrearage  Bonds.    See  Revenue  Bonds. 

311.  Tax  Relief  Bonds.    See  Revenue  Bonds. 

312.  Temporary  Receipts,  strictly  speaking,  are  the  formal 
acknowledgment  by  banking  house,  trust  company,  or  issuing  cor- 
poration, of  the  payment  for  a  bond  not  yet  prepared  for  delivery, 
and  the  promise  to  deliver  the  bond,  when  prepared,  on  surrender 
of  the  receipt  at  the  proper  offices. 

313.  Interim  Certificates  may  signify  the  same  thing  as  Tem- 
porary Receipts,  or  they  may  signify  Temporary  Bonds. 

Temporary  Bonds  and  Interim  Bonds  can  be  distinguished  from 
Temporary  Receipts  in  business  parlance,  for  they  are  not  merely 
acknowledgments  of  value  received,  but  really  substitutes  for  the 
more  carefully  engraved  or  lithographed,  permanent,  "  definitive," 
instrument.  The  essential  recitals  which  will  appear  on  the  face 
of  the  Permanent  Bond  will  be  typewritten  or  printed  on  the 
temporary  bond.  Temporary  Receipts  or  Interim  Certificates  do 
not  carry  coupons,  and  perhaps  the  majority  of  Temporary  Bonds 
do  not;  they  carry  merely  the  space  to  indorse  interest  payments 
in  case  an  interest  period  should  intervene  before  the  definitive 
bonds  were  ready.  The  Tacoma  Gas  Light  Company  Refunding 
5s  of  1926  are  temporary  coupon  bonds  which  have  been  out- 
standing for  five  years. 

314.  The  issuance  of  Temporary  Bonds  (or  Interim  Certificates 


104    CLASSIFICATION  AND  DESCRIPTION  OF  BONDS 

that  are  Temporary  Bonds)  is,  or  should  be,  specially  authorized 
in  the  mortgage  securing  the  regular  bonds,  for  otherwise,  when 
the  Temporary  Bonds  were  recalled,  they,  and  the  loan  they  rep- 
resent, would  be  dead. 

315.  There  is  a  broader  application  of  the  legal  principle  in- 
volved, that  few  Americans,  even  corporation  lawyers,  are  aware 
of.  Through  a  series  of  decisions  the  English  courts  have  arrived 
at  the  conclusion  that  if  a  company  hypothecates  its  own  bonds 
to  secure  a  loan,  those  bonds  are  issued.1  Consequently,  when  the 
loan  is  paid,  if  the  bonds  come  back  into  the  possession  of  the 
company,  they  are  redeemed.  Since  redemption  increases  the  equity 
back  of  any  bonds  of  the  same  issue  that  may  be  outstanding  in 
the  hands  of  the  public,  the  company  cannot  reissue  these  hypoth- 
ecated and  redeemed  bonds  to  make  them  rank  pari  passu  with 
the  previously  outstanding  bonds. 

So  far  as  we  know  the  question  has  never  been  adjudicated  in  our 
courts,  but  the  principle  of  law  back  of  the  English  decisions 
seems  indisputable.  The  holders  of  unhypothecated  bonds  could 
claim,  in  litigation,  a  position  superior  to  holders  of  the  bonds  that 
had  been  hypothecated,  redeemed,  and  reissued;  and  the  Ameri- 
can courts  would  undoubtedly  follow  the  English  decisions. 

316.  Temporary  Bonds  or  Certificates  may  not  have  reference 
to  or  implication  of  a  definite  future  issue  of  regular  bonds.  Re- 
ceiver's Certificates  are  Temporary  Certificates. 

317.  Water  Bonds,  and  issues  for  many  other  purposes  not 
specified  here,  are  treated  elsewhere  in  these  pages;  and  to  find 
them  most  readily  the  index  should  be  consulted. 

1 A  bond,  to  be  issued,  must  be  not  only  signed  and  sealed,  but  delivered. 


CHAPTER  XI 

THE    CLASSIFICATION    AND    DESCRIPTION    OF    BONDS: 

ACCORDING  TO  CONDITIONS  ATTENDING  PAYMENT 

OF  INTEREST  OR  PRINCIPAL 

318.    The  fourth  classification,  relating  to  the  payment  of  princi- 
pal and  interest,  may  be  subdivided  as  follows: 

(a)  According  to  Payment  of  Interest: 

Bonds  of  Unconditional  Interest 

f  Cumulative 


Income  Bonds 


Adjustment  Bonds 


Non-Cumulative 


Participating  Bonds  \  (  Limited 

Dividend-Sharing  Bonds    I  J  Uniimited 

Profit-Sharing  Bonds  J  ( 

Registered  Bonds 
Registered  Coupon  Bonds 
Coupon  Bonds 
Interchangeable  Bonds 

Tax-receivable  Bonds 
High  Rate  Bonds 
Low  Rate  Bonds 
High  Yield   Bonds 
Low  Yield  Bonds 
(b)  According  to  Payment  of  Principal: 
Premium  Bonds 
Gold  Bonds 
Silver  Bonds 
Currency  Bonds 
Legal  Tender  Bonds 

105 


106     CLASSIFICATION  AND  DESCRIPTION  OF  BONDS 

(c)  According  to  Maturity  of  Principal: 

Straight  Bonds 
Serial  Bonds 
Equal  Instalment  Bonds 
Long  Term  Bonds 
Short  Term  Bonds 
Deferred  Bonds 
Extended  Bonds 
Perpetual  Loans 

(d)  With  Maturity  at  the  Option  of  the  Payor: 

Redeemable  Bonds 
Callable  Bonds 
Optional  Bonds 
Irredeemable  Bonds 

(e)  With  Maturity  at  the  Option  of  the  Payee: 

Optional  (with  the  payee)  Bonds  or 
Cash  Surrender  Bonds 
Annuity  Bonds 
Endowment  Bonds 
Convertible  Bonds 

319.  Division  According  to  Payment  of  Interest.  Unconditional 
Interest  is  hardly  a  title  for  a  class  of  bonds;  but  it  is  a  phrase 
descriptive  of  all  issues  the  interest  of  which  is  obligatory  as  long  as 
the  company  is  solvent.  Income,  Adjustment  Issues,  and  the  like, 
are  the  only  exceptions  to  bonds  of  unconditional  interest. 

320.  Income  Bonds  already  have  been  treated.  Their  peculiar 
characteristic  is  that  the  interest  is  dependent  on  the  revenue  of 
the  obligor.  Generally  the  trust  deed  stipulates  that  if  the  entire 
interest  charge  on  the  issue  is  not  earned  such  portion  as  is  earned 
shall  be  paid.  Sometimes  unpaid  interest  accumulates  as  a  charge 
against  future  earnings.  In  this  event  the  bonds  are  Cumulative 
Income  Bonds;  otherwise  they  are  ~S on-Cumulative. 

321.  Adjustment  Bonds  is  a  title  which  nominally  expresses  a 
purpose  and  might  at  first  seem  to  come  under  the  third  classifica- 
tion with  more  propriety:  for  they  are  issued  to  adjust  a  debt  that 
has  been  compromised  or  adjudicated.  The  leading  obligation  of 
the  kind  is  the  Atchison  Adjustment  4s  of  1995.  A  reading  of  the 
trust  deed  will  show  that  these  are  Mortgage  Income  Bonds,  non- 
cumulative  prior  to  July  1,  1900;  but  of  course  the  mortgage  could 
not  be  foreclosed  until  maturity.    The  use  of  the  word  Adjustment 


ACCORDING  TO  CONDITIONS  ATTENDING  PAYMENT    107 

instead  of  Income  is  to  avoid  the  more  unpleasantly  descriptive 
adjective. 

322.  Participating^  Bonds  are,  in  a  sense,  the  opposite  of  Income 
Bonds.  In  Income  Bonds  the  interest  paid  may,  without  redress,  run 
from  a  certain  maximum  rate  down  to  nothing;  whereas  in  Partici- 
pating Bonds  the  income  may  run  from  a  certain  minimum  to  a  cer- 
tain maximum  (in  limited  participation)  or  to  whatever  is  earned 
(in  unlimited  participation).  Participation  bonds  are  very  likely  to 
be  collateral  trust,  in  the  nature  of  the  case;  and  the  participation 
feature  is  conceded  to  offset  possible  deficiency  in  the  collateral 
security,  which  is  likely  to  be  stock.  When  the  dividend  on  this 
stock  is  more  than  sufficient  to  pay  interest  charges  on  the  secured 
bonds,  a  portion  of  the  surplus  goes  as  a  sort  of  dividend  to  the 
bondholders.  Therefore  bonds  of  this  type  are  also  sometimes 
called  Dividend  Bonds  or  Profit  Sharing  Bonds;  but  particularly 
when  these  issues  are  called  Profit  Sharing  Bonds  the  indenture 
provides  that  a  certain  proportion  of  the  company's  entire  net 
earnings  shall  go  to  the  bondholders.  Real  Estate  Debentures  are 
often  profit-sharing. 

323.  As  to  methods  of  collecting  interest,  and  of  transferring 
bonds,  there  are  four  classes:  Registered,  Registered  Coupon,  Cou- 
pon, and  Interchangeable  Bonds. 

The  ownership  of  Registered  Bonds  is  evidenced  by  registration 
in  the  transfer  office  of  the  issuing  company  or  municipality. 
Transfer  of  title  is  accomplished  only  by  indorsement  on  the  back 
of  the  instrument  by  the  payee:  i.e.  the  person  in  whose  name  it 
is  registered.  The  bond  must  then  be  sent  to  the  transfer  office  for 
re-registration. 

For  convenience  in  making  sale,  or  for  other  reasons,  it  may  be 
desirable  to  make  a  "  transfer  in  blank :"  i.e.  the  line  destined  for 
the  name  of  the  transferee  or  assignee  may  be  left  blank.  The 
bonds  then  become  payable  to  bearer.  But,  as  in  the  case  of  stocks, 
the  owner  of  the  certificate,  in  the  eyes  of  the  company,  is  the 
person  in  whose  name  it  is  registered;  and  to  this  person  the  in- 
terest check  will  be  mailed.  Therefore  it  is  desirable  that  transfers 
should  be  registered  promptly. 

324.  Registered  Coupon  Bonds  are  bonds  registered  as  to  princi- 
pal, but  with  interest  coupons  attached,  which  pass  by  delivery 
and  are  payable  to  bearer. 

325.  Coupon  Bonds  are  negotiable  instruments  that  ordinarily 
do  not  have  on  them  the  name  of  the  owner.    Therefore  they  pass 


108    CLASSIFICATION  AND  DESCRIPTION  OF  BONDS 

from  hand  to  hand  like  bank  notes.  Interest  is  paid  on  surrender 
of  the  coupons,  clipped  from  the  bonds — "  little  promissory  notes," 
as  they  mature,  one  each  interest  day. 

326.  For  many  years  it  has  been  a  common  privilege  to  make 
coupon  bonds  convertible  into  registered  bonds  at  the  will  of  the 
owner.  But  only  recently  have  registered  bonds  been  frequently 
endowed  with  the  privilege  of  conversion  into  coupon.  When  the 
bonds  of  an  issue  may  be  converted  either  way,  at  will,  they  are 
called  Interchangeable  Bonds.  When  an  issue  appears  in  both  cou- 
pon and  registered  forms,  and  is  actively  dealt  in,  the  results  of 
interchangeability  are  attained  by  the  sale  of  the  one  form  and 
the  purchase  of  the  other.  United  States  bonds,  therefore,  have 
the  essential  advantage  of  interchangeability;  but  since  coupon 
bonds  are  in  better  demand  than  registered  and  sell  at  better  prices, 
it  is  easier  to  convert  coupon  bonds  into  registered,  without  loss, 
than  to  reverse  the  exchange. 

327.  The  distinct  advantage  of  a  registered  bond  is  that  payment 
of  interest  and  principal  can  be  stopped  in  the  event  of  loss  or 
theft.  There  is  an  increase  in  safety  to  the  obligor,  also.  New 
York  City  lost  about  $200,000  some  thirty  years  ago,  by  making 
several  payments  for  the  same  coupons. 

The  disadvantage  of  a  registered  bond  to  an  investor  is  the  in- 
convenience and  expense  attending  its  transfer.  The  expense,  be- 
sides a  possible  registration  fee,  is  the  cost  of  shipment,  including 
insurance  and  the  loss  of  interest.  Registered  bonds,  moreover, 
are  more  difficult  to  hypothecate. 

328.  Tax  Receivables  are  civil  coupon  debentures,  both  state  and 
municipal,  the  coupons  of  which  are  receivable  (i.e.  legal  tender) 
in  payment  of  taxes  due  the  issuer.  They  are  very  common  in  Vir- 
ginia. The  legal  tender  provision  enhances  the  security  of  in- 
terest quite  independently  of  security  of  principal,  for  it  gives  the 
coupons  a  theoretically  certain  redemption  value.  Neverthe- 
less, even  tax-receivable  bonds  and  their  coupons  have  been 
repudiated.  Needless  to  say,  since  the  tax-receivable  device  is  a 
bolster  to  poor  credit,  such  municipals  are  seldom  issued  of  late 
years. 

329.  The  interest  rate  that  issues  bear  gives  rise  to  the  self- 
explanatory  designations  High  Rate  and  Low  Rate  Bonds.  Those 
practised  in  bond  dealings  can  read  much  history  into  the  interest 
rates  of  a  state,  city,  or  corporation.  The  rates  prevailing  on 
United  States  bonds,  both  long  and  short  term,  issued  during  our 


ACCORDING  TO  CONDITIONS  ATTENDING  PAYMENT    109 

several  wars,  are  a  sufficient  index  of  the  mutable  credit  of  the 
strongest  governments. 

In  those  states  (and  they  are  in  the  majority)  that  do  not  permit 
municipalities  to  sell  their  loans  below  par,  it  is  possible  to  sense 
the  growth  in  credit  and  the  decline  in  interest  rates  for  money, 
by  noting  the  gradual  decline  in  the  interest  rates  borne  by  munici- 
pal loans.  Much  significant  bond  history  is  told  in  the  City  of 
Albany,  N.  Y.,  Washington  Park  Bonds,  with  gradually  lowered 
interest  rates  from  7  per  cent,  in  1870  to  6s  in  1875,  to  5s  in  1878, 
to  4s  in  1880,  to  2s  in  the  money-drugged  market  of  1894,  and  up 
to  3|s  under  the  withdrawal  of  funds  from  investment  channels 
in  1896.  Likewise  when  a  city,  like  Richmond,  Va.,  is  able  to  re- 
fund an  8  per  cent,  issue  by  a  4  per  cent.  But  on  the  other  hand, 
when  a  community  like  Garfield  County,  Col.,  has  still  outstanding 
some  7  per  cents,  subject  to  call  in  1902,  and  6  per  cents,  subject 
to  call  in  1905,  one  is  inclined  to  ask  the  reason.  Or  again, 
when  we  find  very  few  municipal  bonds  in  New  Mexico  bearing 
interest  below  5  per  cent,  we  realize  that  municipal  credit  is  a 
relative  thing. 

330.  High  Yield  and  Low  Yield  Bonds  do  not  necessarily  corre- 
spond with  High  Rate  and  Low  Rate.  A  6  per  cent,  bond  selling  at 
a  high  premium  may  be  of  lower  yield  than  a  3  per  cent,  bond 
selling  at  a  discount.  The  whole  matter  of  net  yield  is  treated  in 
Chapters  XXXIV  to  XXXYI  inclusive. 

331.  Division  According  to  Payment  of  Principal.  Several  bond 
titles  are  derived  from  facts  relating  to  the  amount  or  character 
of  the  principal  repaid.  Frequently  European  government  bonds 
and  rarely  American  municipal  and  corporation  issues  must  be 
retired  at  a  premium.  These  are  called  Premium  Bonds.  New 
Orleans  has  a  municipal  issue  of  the  kind;  a  corporation  issue  is 
mentioned  in  §  1269.  Bonds  selling  at  a  premium  are  also  called 
Premium  Bonds;  and  bonds  selling  at  a  discount  are  called  Dis- 
count Bonds. 

332.  As  to  the  funds  acceptable  in  payment  at  maturity,  Gold 
Bonds  call  for  payment  in  gold  "  of  the  present  standard  of  weight 
and  fineness,"  if  demanded.  Silver  Bonds  are  practically  unknown 
to  us,  although  common  enough  in  the  past  in  countries  that  had 
a  silver  standard.  Currency  Bonds  are  payable  in  currency:  i.e. 
may  be  paid  in  anything  that  is  a  legal  tender,  including  paper 
money.  Legal  Tender  Bonds  is  a  title  practically  synonymous  with 
the  preceding. 


110    CLASSIFICATION  AND  DESCRIPTION  OF  BONDS 

333.  If  there  is  a  difference  in  the  value  of  the  several  kinds  of 
currency  the  bond  owner  will  be  given  the  least  valuable.  If  it 
were  certain  that  this  country  would  always  maintain  a  gold 
standard,  no  importance  could  be  attached  to  the  title  Gold  Bonds. 
The  weaker  an  issue  is  the  more  emphasis  laid  on  the  word 
gold. 

334.  Division  According  to  Maturity  of  Principal.  Relative  to  the 
amount  of  an  issue  that  matures  at  any  one  time  we  have  Straight, 
Serial,  Instalment,  and  Equal  Instalment  issues. 

335.  "  Straight "  Bonds  are  by  far  the  commonest.  They  are 
issues  that  nominally  mature  all  at  one  time,  although  they  may 
be  redeemable  in  whole  or  in  part  before  the  ultimate  maturity 
date. 

336.  Serial  Bonds  are  issues  that  are  retired  in  regular  instal- 
ments. If  serial  the  presumption  is  a  reasonable  uniformity  in 
amount  retired  each  period  and  in  the  interval  between  periods. 
Serial  retirement  does  away  with  the  necessity  for  sinking  funds, 
and  therefore  is  the  most  economical  way  to  attain  the  maximum 
of  assurance  through  amortization.  The  serial  principle  is  ex- 
plained in  the  chapters  on  Equipment  Bonds  and  Municipal 
Bonds. 

337.  Equal  Instalment  Bonds  (generally  Equal  Annual  Instal- 
ment Bonds)  carry  the  serial  retirement  principle  to  its  ultimate 
refinement:  namely,  that  the  amount  of  principal  and  interest  to 
be  paid  each  period  shall  be  such  that  the  periodical  cost  to  the 
obligor  shall  not  vary.  Since  the  interest  charge  lessens  with  the 
decrease  in  principal,  that  part  of  the  total  periodical  payment 
which  is  the  repayment  of  principal,  grows  constantly  larger.  In 
order  that  it  may  not  be  necessary  to  issue  bonds  of  odd  denomina: 
tions,  the  equal  periodic  instalment  payment  may  be  approximated 
at  each  interest  period,  to  the  nearest  $1,000  or  $500  piece,  accord- 
ing to  the  denomination  of  the  issue.  If  the  issue  is  of  any  size 
this  approximation  will  distribute  the  burden  of  repayment  with 
sufficient  uniformity  for  all  practical  purposes. 

Thus  far  Equal  Instalment  bonds  have  had  their  greatest  vogue 
among  Canadian  municipalities,  although  some  American  indus- 
trial obligations  are  of  the  class. 

338.  Long  Term  Bonds  and  Short  Term  Bonds  are  self-explana- 
tory terms.  The  conditions  governing  the  expediency  of  issuing 
and  purchasing  the  one  or  the  other  are  treated  in  various  places 
throughout   these   pages   as   indexed.     Sufficient   here   that   most 


ACCORDING  TO  CONDITIONS  ATTENDING  PAYMENT    111 

short  term  loans  are  an  emergency  resource  on  the  part  of  the 
obligor — from  the  short  time  notes  of  the  Federal  Government 
issued  by  Secretary  Chase  during  the  Civil  War,  to  the  railroad 
and  industrial  notes  that  are  put  forth  when  money  rates  are 
high,  pending  the  time  that  long  term  loans  will  be  accepted  at 
rates  of  interest  advantageous  to  the  corporation.  Commercial 
paper  is  the  species  of  short  term  obligation  that  is  founded  on  the 
best  principles  of  credit. 

339.  As  far  as  the  expression  "  deferred  "  is  applied  to  bonds  it 
must  signify  what  it  does  in  deferred  stocks — in  antithesis  to  pre- 
ferred stocks — the  postponement  of  payments.  Deferred  Bonds, 
then,  are  such  as  do  not  receive  interest,  or  at  least  the  maximum 
interest  they  are  to  receive,  until  certain  conditions  have  been 
fulfilled  respecting  earnings,  or  an  interval  of  time.  Income  Bonds, 
therefore,  are  potentially  of  the  Deferred  class.  Austin,  Texas,  Re- 
funding bonds  of  1931,  bear  3  per  cent,  interest  for  the  first  five 
years,  4  per  cent,  for  the  next  10  years,  but  the  maximum  5  per 
cent,  is  deferred  until  the  last  15  years.  Respecting  the  functions 
this  issue  performs,  it  is  Refunding,  Adjustment,  and  Deferred. 

340.  When  the  payment  of  the  principal  is  deferred,  but  there 
is  no  change  in  the  status  of  the  mortgage  or  other  security,  the 
issue  mav  be  called  Extended.  New  Extended  Bonds,  with  the 
proper  number  of  coupons,  may  be  created  to  replace  the  old 
bonds,  or  the  facts  and  terms  of  the  extension,  with  the  changed 
interest  rate,  if  there  has  been  a  change,  may  be  stamped  or  printed 
on  the  old  bonds. 

341.  Perpetual,  or  Indeterminate  Loans  are  another  class  with 
a  self-explanatory  title,  which  has  been  discussed  elsewhere  in  this 
book.  If  they  are  coupon-bearing,  the  bonds  will  probably  be  re- 
placed with  new  paper  when  the  coupons  on  the  old  bonds  are  ex- 
hausted. The  Public  Service  Corporation  of  New  Jersey  has  out- 
standing Perpetual,  Deferred,  Interest-bearing  Stock  Trust  Cer- 
tificates, although  the  company  is  wise  enough  not  to  call  them  by 
this  name. 

342.  Division  According  to  Maturity  as  Affected  by  the  Payor's 
Option.  Redeemable,  Callable,  or  Optional  Bonds  are  so  entitled 
because  the  maturity  of  the  loan  is  affected  by  the  payor's  right  to 
retire  the  obligation  before  the  obligatory  maturity  date.  But  the 
privilege  to  retire  usually  can  be  exercised  only  on  an  interest  day 
or  after  some  weeks'  notice.  The  redemption  feature  is  considered 
a  disadvantage  to  the  investor,   particularly  in  municipal  loans, 


112    CLASSIFICATION  AND  DESCRIPTION  OF  BONDS 

which  are  usually  retirable  at  par;1  but  when  the  bonds  may  not 
be  redeemed  except  at  a  premium  sufficiently  high  so  that  the  pro- 
ceeds may  be  invested  in  another  instrument  of  like  safety  but  with 
greater  returns,  no  real  disadvantage  exists. 

343.  Although  the  privilege  of  redemption  may  permit  a  com- 
pany to  refund  its  debts  at  a  lower  rate  of  interest  when  its 
credit  becomes  greater,  or  when  it  can,  by  so  doing,  avail  itself  of 
lower  interest  rates,  it  is  not  solely  for  such  purposes  that  this 
right  is  reserved ;— but  rather  to  place  the  company  in  a  position  to 
consolidate  its  mortgages,  reorganize  its  affairs,  or  to  change  its 
scheme  of  financing  in  any  other  way  that  may  seem  desirable. 

344.  Since  the  net  return  from  a  redeemable  investment  depends 
on  the  length  of  time  the  loan  has  to  run,  and  the  redemption  value, 
it  is  desirable  to  establish  certain  rules  for  the  guidance  of  those 
who  seek  this  net  return.  The  rules  are  given  in  the  chapter  on 
the  Use  of  the  Bond  Tables. 

345.  Issues  that  may  not  be  called  by  the  payor  are  Irredeemable 
Bonds.  To  avoid  confusion  the  denotation  of  Irredeemable  Bonds 
should  not  be  extended,  as  it  commonly  is,  to  cover  what  we  en- 
title here  Perpetual  or  Indeterminate  Loans. 

346.  Division  According  to  Maturity  as  Affected  by  the  Payee's 
Option.  Under  certain  circumstances  a  loan  may  be  terminated  at 
the  option  of  the  payee  as  well  as  of  the  payor.  In  the  effort  to 
make  real  estate  bonds  marketable,  real  estate  companies  sometimes 
give  their  bonds  "  cash  surrender  value,"  as  it  is  called  in  in 
surance.  That  is  to  say,  after  a  period,  which  may  be  two  years, 
the  purchaser  may  return  his  bond  and  receive  the  cost  price  plus 
perhaps  .'>  per  cent,  per  annum  after  deducting  what  has  been 
paid  him  in  interest.  Since  the  interest  he  has  received  is  always 
more  than  3  per  cent,  this  provision  is  tantamount  to  an  agree- 
ment on  the  part  of  the  company  to  repurchase  the  bonds  at  a 
discount  which  increases  as  the  loan  grows  old. 

347.  The  writer  knows  of  no  title  by  which  this  class  has  been 
denominated.  They  are  Optional  as  regards  the  payee,  but  this 
term  offers  no  distinguishment  from  bonds  Optional  or  Redeem- 
able by  the  payor.  In  want  of  a  better  suggestion,  the  writer  ven- 
tures to  submit  the  title  Cash  Surrender  Bonds. 

348.  Convertible  Issues  as  a  form  of  bonus  bonds  were  common 
enough  in  railroad  finance  in  the  sixties  and  seventies,  and  are 

1  An  exception  is  the  Cabell  Co.,  W.  Va.,  Court  House  and  Bridge  bonds, 
redeemable  6,000  yearly  at  102. 


ACCORDING  TO  CONDITIONS  ATTENDING  PAYMENT    113 

now  revived  to  a  greater  popularity  than  ever,  not  only  among 
the  railroads,  but  among  many  other  kinds  of  corporations.  The 
bonds  are  convertible  generally  into  other  securities  of  the  same 
corporation,  but  sometimes  into  the  securities  of  another  corpora- 
tion. Or  again,  the  bonds  are  commonly  convertible  into  stock; 
but  occasionally,  if  unsecured  (i.e.  notes  or  debentures),  or  if  not 
sufficiently  secured  they  may  be  convertible  into  secured  bonds  as 
in  the  case  of  the  Hudson  Companies'  two  issues  of  Convertible 
(Collateral)   6  per  cent.  Notes. 

349.  When  it  is  the  intention  to  convert  bonds  into  stock  it 
must  not  be  forgotten  that  conversion  is  seldom  possible  when  the 
transfer  books  are  closed;  also  that  accrued  dividend,  as  well  as 
accrued  interest,  must  be  reckoned,  unless  the  dividend  and  interest 
fall  on  the  same  date,  or  are  of  the  same  rate;  and  that  one  selling 
and  one  purchasing  commission  must  be  paid. 

To  complicate  matters  further,  different  companies  have  different 
ways  of  figuring  accrued  dividend; — it  may  be  from  the  payment 
of  the  last  dividend,  or  from  the  declaration  of  the  present.  Fur- 
thermore, there  is  no  general  custom  regarding  the  treatment  of 
fractional  shares,  when  at  the  conversion  price  the  bond  is  not  a 
multiple  of  the  stock. 

Fewer  difficulties  are  met  in  converting  bonds  or  stocks  into 
other  bonds,  for  interest  dates  almost  invariably  coincide.  There- 
fore there  is  only  the  probability  of  an  adjustment  for  difference 
in  interest  rate.1 

350.  The  basis  of  the  popularity  of  issues  convertible  into  stock 
is  the  genuine  alliance  in  them  of  investment  and  speculative  vir.- 
tues.  It  is  as  if  for  once  oil  and  water  would  mix.  As  an  invest- 
ment these  bonds  are  to  be  judged  like  any  other  corporate  obli- 
gation,— quite  irrespective  of  the  convertible  feature.  It  will  be 
found  that  they  are  usually  debentures,  or  at  best,  junior  liens. 
Sometimes,  however,  they  are  the  sole  or  major  obligation  of  the 
issuer. 

351.  As  a  speculation,  an  issue  convertible  into  stock  will  ad- 
vance with  the  stock — there  is  no  limit  when  the  stock  reaches  the 
price  at  which  the  bonds  are  convertible  and  until  and  unless  the 
company  has  the  right  to  retire  the  issue  and  exercises  that  right. 
On  the  other  hand,  however  low  the  stock  may  fall,  the  bonds  will 
not  decline  below  their  true  investment  value  as  an  obligation  of 

1  For  further  details  and  helpful  tables  consult  the  excellent  work,  Convertible 
Securities,  Montgomery  Rollins,  Boston,  1909. 


114     CLASSIFICATION  AND  DESCRIPTION  OF  BONDS 

the  company;  and  they  may  not  decline  even  to  the  investment 
level  because  of  the  potential  speculative  value  of  the  conversion 
privilege.  It  is  not,  of  course,  necessary  to  convert  the  bonds  to 
realize  profits.  The  sale  of  the  bonds  themselves  will  probably 
suffice. 

352.  Bonds  convertible  into  stock,  but  especially  convertible 
bonds  of  industrial  and  other  corporations  that  have  for  sale  a  com- 
modity which  is  not  restricted  by  law  or  custom  as  to  price,  have 
possibly  an  advantage  over  other  bonds  in  case  the  increase  in  the 
world's  supply  of  gold  shall  lessen  the  purchasing  power  of  money. 
For,  as  the  purchasing  power  of  money  declines,  and  commodities 
advance  in  price,  the  corporations  prosper  that  control  or  manu- 
facture commodities,  and  the  stocks  of  those  corporations  increase 
in  value.  As  the  purchasing  power  of  money  declines,  so  also  the 
purchasing  power  or  value  of  a  fixed  sum  like  bond  interest  or 
principal.  But  the  convertible  bondholder  is  prepared  for  either 
event:  the  increase  in  the  value  of  money  or  of  commodities.  There- 
fore, as  the  saying  is,  "  heads  he  wins  with  the  stock,  and  tails  he 
wins  with  the  bond." 

The  application  of  this  gold  supply  theory  to  convertible  bonds 
will  readily  be  understood  by  reference  to  the  chapters  on  The 
Course  of  Bond  Prices. 


y  inc.  ^  *«  jjjh  £ 


^A^os^w    oyv  M.Slcs, 


PART  II 
CIVIL  LOANS 

CHAPTER  XII 
UNITED  STATES  BONDS 

353.  The  scope  of  this  work  does  not  bring  us  into  the  general 
field  of  government  securities  as  investments.  It  is  perhaps  as 
profound  a  subject  as  any  in  the  category  of  finance.  Its  successful 
solution  in  France's  case  was  her  salvation  in  the  early  seventies, 
and  is  now  her  perpetual  boast.  Our  government  bonds,  however, 
do  not  serve  the  same  purpose  as  French  rentes,  for  our  fiscal 
system  is  entirely  different,  and  it  is  a  far  cry,  even,  from  our 
national  funds  to  British  consols. 

354.  Nor  are  we  concerned,  except  indirectly,  in  the  relation  of 
government  bonds  to  our  banking  system.1  For  the  purpose  of  an 
elementary  treatise  on  the  principles  of  bond  investment  it  is  suffi- 
cient to  confine  the  discussion  to  the  desirability  of  United  States 
government  bonds  for  private  purchase. 

355.  Net  Yield.  At  the  time  these  pages  were  written  the  4s 
of  1925  were  selling  at  114  and  yielded  an  income  of  2.70  per  cent, 
on  the  investment.  The  State  of  Massachusetts  tax-exempt  long 
term  3^s  were  selling  on  a  3.50  per  cent,  income  basis.  During  the 
Civil  War  Massachusetts  paid  the  maturing  principal  and  interest 
on  all  her  obligations  in  gold.  Her  credit,  in  spite  of  a  very  large 
state  debt,  is  of  the  highest.  Both  of  the  issues  mentioned  are 
obligations  created  by  sovereign  states,  against  which,  in  default, 
there  is  yet  to  be  found  practicable  means  of  redress;  and  for  the 
security  of  which,  therefore,  as  stated  in  the  following  chapter, 
there  is  nothing  but  the  sovereign  credit.  If,  then,  the  difference 
in  income  between  the  Government  4s  and  the  State  3^s,  amounting 
to  eight-tenths  of  1  per  cent.,  represents  the  difference  in  degree 
of  security,  there  is  much  to  be  said  in  favor  of  United  States  gov- 
ernments for  private  investment.  The  difference  in  income  yield 
would  have  been  still  greater,  namely  one  and  one-quarter  per  cent., 
had  we  cited  State  of  Massachusetts  long  term  taxable  3^s,  registered 

1  For  the  relation  of  national  bank  note  circulation  to  United  States  Bonds,  see 
the  appeudix. 

115 


in;  united  states  bonds 

or  coupon,  selling  on  a  3.9")  basis.  If  now  we  compare  the  coupon 
34s  of  this  taxable  issue  with  the  Government  2s  of  1930,  selling  at 
101,  a  1.93  per  cent,  basis,  we  find  a  difference  in  yield  of  over 
2  per  cent.,  assuming  Ibat  faxes  are  not  paid  on  the  Massachusetts 
coupon  3£s, — often  an  assumption  not  contrary  to  fact,  as  the 
grammarians  would  say.  If  tbis  ratio  of  yield  represents  a  pro- 
portionate ratio  of  security,  therefore,  the  United  States  govern- 
ment 2s  of  1930  are  more  than  twice  as  safe  an  investment  as  long 
term  Massachusetts  taxable  coupon  3|s.  This  sort  of  reasoning 
smacks  of  the  Middle  Ages,  but  it  is  when  thus  reduced  to  an  ab- 
surdity that  the  error  becomes  most  plainly  apparent  of  attempting, 
in  most  classes  of  bonds,1  to  determine  the  relative  security  of  dif- 
ferent classes,  or  of  different  bonds  in  the  same  class  by  the  respec- 
tive rates  of  yield.  Yet  this  is  by  no  means  an  uncommon  practice. 
In  the  case  of  government  bonds  it  is  manifest  that  other  influences 
are  at  work  adjusting  the  rate  of  income  beside  the  feeling  of 
security  that  sound  public  credit  inspires.2 

356.  Causes  of  the  Low  Rate.  Yet  it  is  not  to  be  denied  that  the 
United  States  is  able  to  float  a  new  loan  on  less  than  a  2  per  cent, 
basis,  an  achievement,  we  believe,  possible  to  no  other  nation,  largely 
because  of  her  unsurpassed  credit.  From  the  appointment  of  our  first 
Secretary  of  the  Treasury  to  the  present  there  have  always  been  at 
hand  those  who  would  remind  an  improvident  Congress  or  a  forget- 
ful public  that  credit  is  confidence,  and  that  confidence  is  best 
fostered  by  the  prompt  discharge  of  obligations.  To  the  example 
set  by  the  United  States  is  due,  in  large  measure,  the  fact  that 
national  debts  the  world  over  are  no  longer  looked  upon  so  much 
as  perpetual  loans,  but  rather  as  promises  to  pay.  The  history  of 
our  own  public  debt  is  a  record  of  obligations  almost  unavoidably 
created  and  speedily  discharged. 

357.  History  of  the  National  Debt.  The  Treasury  Department, 
created  in  1789,  faced  a  national  debt  of  $79,000,000.  In  spite  of  a 
new  loan  of  $13,000,000  raised  for  the  purchase  of  Louisiana  the  debt 
had  been  reduced  in  1812  to  $45,000,000.  The  costly  four  years'  war 
with  Great  Britain  increased  this  amount  to  $127,000,000,  but  the 
entire  public  debt  was  paid  by  1835.  Tbe  Mexican  War  and  the 
payment  of  the  Texan  indemnity  created  a  new  debt  of  $G8,000,000 
in  1851,  and  Indian  wars  and  other  troubles  increased  this  until  at 

1  A  possible  exception  is  municipal  bonds. 

2  The  new  insular  issues  yield  nearly  3  per  cent.,  but  they  have  not  the  same  in- 
stitutional availability  with  the  consequent  artificial  market. 


UNITED  STATES  BONDS  117 

the  opening  of  the  Civil  War  it  amounted  to  $90,000,000.  The 
enormous  expenditures  of  the  next  four  years  brought  the  total  up 
to  $2,800,000,000,  the  high-water  mark.  Since  1865,  in  spite  of 
large  bond  issues  to  facilitate  the  resumption  of  specie  payment  in 
1879,  and  to  increase  the  gold  reserves  in  1891,  1895,  and  1896,  and 
to  finance  the  Spanish  War  in  1898,  and  to  purchase  the  Philippines 
in  1904,  and  to  build  the  Panama  Canal  in  1906,  1908,  and  1911, 
our  debt  has  shown  a  constant  tendency  to  decrease,  and  is  now 
approximately  $1,000,000,000,  with  the  smallest  interest  charge  of 
any  of  the  great  powers  except  Germany. 

358.  The  United  States  a  Debt-Paying  Nation.  The  United  States 
has  appropriately  been  called  a  debt-paying  nation.  Our  latest  issues, 
the  Panama  Canal  2s  of  1936,  the  2s  of  1932,  and  the  3s  of  1961,  and 
the  Philippine  Land  Purchase  4s  of  1934,  1935,  1936,  and  1939,  are 
not  in  such  demand  as  the  old  2s,  redeemable  after  April  1st,  1930, 
because,  apart  from  their  interest  rate,  the  two  former  issues  are 
redeemable  after  August  1st,  1916,  and  February  1st,  1914,  respec- 
tively, and  purchasers  of  the  public  funds  have  every  reason  to  believe 
that,  barring  extraordinary  conditions  in  national  finance,  the  several 
charges  will  be  acquitted  at  the  earliest  possible  redemption  periods. 

It  has  been  a  question  debated  by  economists  whether  it  is  sound 
policy  for  a  nation  to  discharge  its  obligations  at  such  heavy  sacri- 
fice of  immediate  prosperity  as  the  United  States  did  in  the  years 
following  the  Civil  War.  It  might  have  been  wiser  to  have  shared 
the  burden  of  war-costs  with  later  generations,  and  to  have  devoted 
the  resources  thus  conserved  to  an  earlier  resumption  of  specie 
payment.  If  the  tax-drain  had  been  less  in  the  late  sixties,  the 
process  of  recovery  might  have  been  more  rapid.  But  whatever  the 
merits  of  the  case  the  fact  remains  that  a  faithful  adherence  to  the 
debt-paying  policy  has  been  a  most  important  factor  in  the  establish- 
ment of  our  present  unsurpassed  credit. 

359.  National  Resources.  The  reliance  of  the  investing  public 
upon  our  national  sensitiveness  to  funded  obligations  x  is  fortified 
by  knowledge  of  our  ability  to  meet  them.  No  other  nation  has 
within  its  proper  confines  our  diversity  and  wealth  of  resources. 
No  other  nation  is  so  favored  by  climate  and  geographical  position 
for  self-subsistence,  not  only  in  physical,  but  also  in  industrial,  com- 
mercial, and  financial  life. 

1  It  is  a  pity  this  sensitiveness  does  not  extend  to  the  payment  of  just  claims 
of  other  kinds.  The  United  States  is  proverbially  dishonest  in  its  treatment  of 
personal  claims,  even  after  they  have  passed  the  claims  court. 


118  UNITED  STATES  BONDS 

360.  A  Home  Market  for  National  Loans.  So  latterly  we  are  find- 
ing ourselves  less  and  less  in  want  of  foreign  aid  for  the  exploitation 
of  the  undeveloped  portions  of  the  country.  The  industrial  depres- 
sion of  the  winter  of  11)07-1908  was  felt  most  severely  in  the  older 
states,  and  the  most  active  investment  demands,  when  signs  of  re- 
vival appeared,  were  from  the  Middle  West.  Our  national  credit, 
therefore,  unlike  Russia's,  has  little  to  fear  from  the  disposition  of 
foreign  capital.  We  shall  probably  always  be  able  to  market  our 
national  loans  within  our  borders. 

361.  National  Bank  Demand.  A  contributary  cause  of  the  low  rate 
of  yield  on  non-insular  Governments  is  the  needs  of  our  peculiar 
banking  system.  National  banks  are  required,  under  the  National 
Banking  Act,  to  deposit  with  the  Treasurer  of  the  United  States, 
upon  issuance  of  their  charters,  at  least  $25,000  par  value  in  United 
States  registered  bonds,  unless  their  capital  is  less  than  f  150,000,  in 
which  case  the  amount  of  the  bonds  deposited  shall  be  equal  to  at 
least  one-fourth  the  capital.  If  circulation  of  an  amount  in  excess 
of  the  charter  bonds  is  taken  out  some  issue  of  registered  government 
bonds,  equal  in  amount  at  par  to  the  circulation  desired,  is  deposited 
with  the  Treasurer.1  A  third  source  of  demand  is  the  call  for  govern- 
ment bonds  from  national  banks  designated  by  the  Secretary  of  the 
Treasury  as  depositaries  for  the  public  moneys.  The  face  value  of 
these  bonds  will  equal  the  sums  deposited.  But  in  times  of  emer- 
gency the  Treasury  Department  permits  the  deposit  of  other  high 
grade  bonds.  From  the  quasi-artificial  demands  arising  from  these 
three  kinds  of  national  bank  requirements  (not  to  mention  any 
others),  the  private  investor  has  to  compete  in  purchasing  govern- 
ment funds. 

362.  Price  Fluctuations ;  Past  and  Future.  The  price  of  government 
bonds,  of  course,  like  that  of  all  other  commodities,  is  subject  to 
economic  law.  The  floating  supply  and  the  demand  vary  from  year 
to  year  and  even  from  day  to  day.  The  fluctuations  are  not  so  rapid 
nor  sharp  as  in  most  other  issues,  and  are  the  result  of  somewhat 
different  influences,  but  in  the  course  of  years  they  are  much  greater 
than  most  people  suppose.  In  1901,  for  instance,  the  4s  of  1925 
sold  at  about  140.  The  price  at  writing  was  about  114,  a  loss  of 
26  points,  or  19  per  cent.  A  brief  review  of  past  great  price  move- 
ments in  the  securities  may  be  instructive.  They  will  be  more 
easily  appreciated  if  put  in  terms  of  approximate  income  yield. 

1  All  issues  of  United  States  bonds  are  available  as  security  for  circulation  with 
tbe  exception  of  the  Panama  3s  of  1961. 


UNITED  STATES  BONDS 


119 


363.  Fluctuation  in  Times  of  War.  It  is  in  time  of  war,  naturally, 
that  government  credit  is  most  impaired.  In  the  earlier  periods  of 
our  history  when  the  Central  Government  existed  by  mere  sufferance 
and  the  primacy  of  statehood  and  the  right  of  state  secession  were 
not  yet  treasonable  doctrines,  armed  conflict  was  even  a  more  serious 
thing  to  investors  than  it  would  be  under  present  conditions.  The 
War  of  1812  caused  the  issuance  of  loans  upon  a  basis  of  from 
7  to  8|  per  cent.,  and  the  War  of  Secession  upon  a  basis  of  12  per 
cent.,  maximum.  No  bond  value  tables  at  our  command  are  ex- 
tensive enough  to  record  the  price  of  the  Old  2s  of  1930  on  a  12 
per  cent,  basis. 

364.  Although  a  future  war  of  magnitude  would  not  threaten 
the  disintegration  of  the  country,  yet  it  might  have  sufficient  train 
of  evil  consequences  to  work  temporary  havoc  to  our  credit;  for  a 
great  conflict,  with  or  without  blockade,  seriously  curtails  income 
from  customs  duties,  and  almost  over  night  empties  an  unprepared 
treasury.  The  relief  invoked  through  war-taxes  is  unwelcome  and 
tardy.  Then  recourse  must  be  had  to  large  and  numerous  loans 
when  people  are  least  desirous  of  taking  them  up.  At  such  a  time, 
if  ever  it  comes  again,  there  will  be  great  shrinkage  in  the  value  of 
our  public  funds. 

365.  Fluctuation  in  Time  of  Panic.  In  time  of  panic,  on  the  other 
hand,  experience  has  shown  that  no  other  security  will  so  nearly 
hold  its  own.  When  almost  all  industrial  and  commercial  enter- 
prises are  under  suspicion,  government  securities,  by  force  of  con- 
trast, seem  all  the  stronger.  It  is  well  known  to  bond  dealers  that 
the  first  securities  to  enhance  after  business  depression  are  the 
highest  grade  bonds,  especially  municipals.  The  principle  that  be- 
gins to  work  in  this  case  is  the  one  that  is  operative  in  government 
bonds  at  the  worst  of  times.  Furthermore  there  is  usually  less 
pressure  to  liquidate  among  the  classes  of  institutions  and  investors 
that  hold  government  bonds,  and  for  the  bonds  that  are  offered  a 
ready  market  may  be  had  among  the  stronger  national  banks.  In 
the  panic  of  1893  the  average  extreme  variation  of  governments  was 
about  5  points,  and  in  1907  5.7  points  * ;  for  the  better  class  of  mu- 
nicipals and  railroads  during  these  years  the  variation  was  from 
twice  to  four  times  as  much. 

366.  Effect  of  Banking  and  Currency  Measures  Upon  Prices.  Besides 
the  effects  of  war  and  panic,  and  of  the  rise  and  fall  of  ordinary 

1  The  extreme  variation  of  the  2s  and  3s  was  only  3.05  points,  but  the  average 
was  raised  by  the  greater  variation  of  the  less  active  4s. 


r 


/• 


120  UNITED  STATES  BONDS 

interest  rates,  to  which  all  securities  are  subject,  there  is  always 
to  be  considered  the  possibility  of  special  banking  and  currency 
legislation  thai  will  alter  the  stains  of  government  bonds  as  com- 
pulsory banking  investment  and  in  this  way  establish  a  new  basis 
of  prices,  perhaps  higher,  but  in  all  probability  lower  than  the  pres- 
ent. Simply  the  withdrawal  of  circulation,  with  its  consequent 
release  of  deposited  government  bonds,  has  a  tendency  to  soften  the 
market. 

367.  Our  banking  system  is  so  notoriously  bad  that  some  radical 
change  seems  imminent,  but  its  effect  on  bond  prices  can  only  be 
surmised.  It  was  only  fourteen  years  ago  that  as  the  result  of 
unwise  currency  laws  the  United  States  was  obliged  to  issue  over 
$102,000,000  of  bonds  to  draw  gold  into  the  Treasury  to  maintain 
the  parity  of  currency  issues;  and  the  loan  had  to  be  put  out  on 
about  a  3f  per  cent,  basis.  There  is  hardly  a  limit  that  could  be 
put  on  the  range  of  price  possibilities  should  we  change  from  a 
debt-secured  currency  system  to  some  rational  system  based  on 
commercial  assets.  Over  50  per  cent,  of  all  our  government  bonds 
have  been  bought  by  national  banks  (though  the  banks  sometimes 
borrow  of  brokers  for  this  purpose)  and  deposited  in  the  Treasury 
to  secure  note-circulation.  Probably  it  would  go  hard  with  present 
holders  should  the  price  support  from  the  needs  of  national  bank 
circulation  be  withdrawn. 

368.  Desirability  of  United  States  Bonds  for  Investment.  Therefore, 
as  one  realizes  the  variety  of  influences  which  may  in  the  future,  as 
in  the  past,  affect  the  value  of  United  States  government  bonds,  he 
may  think  with  some  reason  that  present  prices  are  too  high  to 
justify  the  investment  of  private  capital  in  them.  Yet  it  should  not 
be  forgotten  that  no  other  form  of  security  is  so  readily  convertible 
into  coin  of  the  realm,  especially  in  times  of  financial  panic. 

369.  Details  Concerning  United  States  Bonds.  The  credit  of  the 
United  States  is  now  loaned  only  in  furtherance  of  strictly  national 
and  public  enterprises.  The  bonds  bear  interest  at  2,  3,  and  4  per 
cent.,  and  are  in  both  coupon  and  registered  form,  and  in  denomina- 
tions of  $20,  $50,  $100,  $500,  $1,000,  $5,000,  $10,000,  $20,000,  $50,000. 
They  are  bought  and  sold  on  the  New  York  Stock  Exchange,  but 
most  dealing  is  done  outside  through  banking  houses,  particularly 
those  making  a  specialty  of  the  public  funds.  Like  odd  lots  of  stock, 
denominations  of  less  than  $1,000  cannot  be  bought  or  sold  quite 
at  the  market.  Coupon  bonds  find  the  readier  sale  and  generally 
bring  fractionally  better  prices.    They  are  convertible  at  the  Treas- 


UNITED  STATES  BONDS  121 

ury  into  registered  bonds  of  the  same  loan  without  cost  except  trans- 
mission charges.  Registered  bonds  are  not  convertible  into  coupon, 
but  as  the  demand  for  coupon  bonds  is  slightly  better,  the  sale  of 
the  one  and  the  purchase  of  the  other  are  accomplished  without 
difficulty.  Reference  to  the  advantages  and  disadvantages  of  the 
two  forms  is  made  in  Section  326  and  following.  The  transfer  of 
ownership  in  registered  government  bonds  is  such  a  technical  pro- 
ceeding that  coupon  bonds  are  to  be  preferred  for  temporary  in- 
vestment when  accommodations  are  at  hand  for  their  safe  keeping. 
In  the  Appendix  will  be  found  a  discussion  of  United  States  Bonds 
in  relation  to  national  bank  note  circulation. 

•  /   j^U  ,  \  >> 


CHAPTER  XIII 
STATE  BONDS:  THE  HISTORY  OF  STATE  DEBT1 

370.  State  Bonds  in  the  Scheme  of  Classification.  Although,  as  we 
said  in  discussing  the  various  kinds  of  bonds,  there  are  some  techni- 
cal grounds  for  classifying  what  are  commonly  called  Municipal 
Issues  as  Government  Bonds,  still  the  more  reasonable  line  of  sever- 
ance is  between  Federal  and  State  Government  Bonds  on  the  one 
hand,  and  Municipal  Bonds  on  the  other.  Not  all  civil  and  political 
divisions,  by  the  way,  are  strictly  governmental  divisions ;  many  are 
created  by  legislative  enactment  for  the  sole  purpose  of  internal 
betterment  by  means  of  funds  raised  from  the  creation  of  debt, 
and  have  no  administrative  functions  apart  from  the  creation  and 
discharge  of  the  debt  and  the  distribution  of  its  proceeds.  There- 
fore it  is  best  to  consider  United  States  Government  and  State 
Bonds  as  the  upper  division  of  Tax  Bonds  or  Civil  Loans,  and 
County,  City,  Village,  District  Bonds,  etc.,  as  the  lower. 

The  logic  of  this  bipartite  division  will  be  clearer  when  we  have 
considered  the  nature  of  state  and  municipal  debt. 

371.  State  Debt  and  Constitutional  Law.  One  of  the  fundamental 
tenets  of  our  constitutional  law  relates  to  the  so-called  sovereignty 
of  the  several  states.  Not  the  general  nature  or  scope  of  this  familiar 
principle,  but  only  its  reference  to  financial  matters  concerns  us. 

Among  the  many  privileges  reserved  by  the  individual  states  at 
the  birth  of  the  Republic  was  a  large  measure  of  autonomy  in  their 
fiscal  relations.  To  be  sure  the  states  could  not  coin  money,2  emit 
bills  of  credit,  make  anything  but  gold  and  silver  a  tender  in  pay- 
ment of  debts,  lay  any  duties  on  imports  or  exports  or  tonnage,  and 
could  not  impair  the  obligation  of  contracts,  (Constitution,  Article 
I,  Section  10),  but  they  secured,  within  four  years  from  the  adop- 
tion of  the  Constitution,  the  specific  concession  that  such  powers 

1  Because  of  the  intimate  relation  between  state  and  municipal  credit,  the  two 
chapters  on  State  Bonds  should  be  read  not  only  by  those  interested  in  state 
bonds,  but  by  all  to  whom  American  government  or  municipal  issues  of  any 
sort  are  of  interest. 

-  A  right  still  retained  by  them  under  the  Articles  of  Confederation. 

122 


STATE  BONDS:  THE  HISTORY  OF  STATE  DEBT      123 

as  were  "  not  delegated  to  the  United  States  by  the  Constitution, 
nor  prohibited  by  it  to  the  States,"  were  "  reserved  to  the  States  re- 
spectively, or  to  the  people"  (Amendments,  Article  X).  This  and 
one  or  two  other  of  the  ten  amendments  that  were  adopted  before 
the  close  of  1791  were  a  direct  result  of  the  still  growing  tendency 
toward  what  was  called  "  state  sovereignty."  If  not  mentioned  in 
the  Constitution  itself,  the  right  of  the  states  to  create  debt  in  the 
manner  of  the  National  Government,  and  upon  the  basis  of  state 
credit,  as  in  the  days  of  the  Confederation,  is  certainly  implied  in 
the  Tenth  Amendment. 

Therefore  we  derive  the  basis  of  our  division  particularly  from  this 
residual  sovereignty  of  the  states, — from  their  ability  to  contract 
debt  without  the  let  or  hindrance  of  a  superior  power,  as  distin- 
guished from  the  dependence  of  the  civil  divisions  of  the  states  upon 
statute  and  state  constitution. 

372.  There  is,  however,  another  feature  of  American  constitu- 
tional law  that  associates  bonds  of  the  commonwealths  still  more 
closely  with  those  of  the  nation,  and  draws  us  further  into  a  study 
of  their  character  and  history.  There  was  nothing  of  especial  mo- 
ment to  state  credit,  about  the  Tenth  Amendment  or  any  of  the 
other  provisions  that  had  gone  before.  In  fact  the  ordination  of 
finance,  important  as  it  was  in  the  years  of  depleted  resources  fol- 
lowing the  drain  of  the  War  for  Independence,  took  a  place,  in  the 
minds  of  the  people  and  of  the  framers  of  the  Constitution,  quite 
secondary  to  the  development  of  a  political  system  which  was  to 
be  the  wonder  and  study  of  continental  Europe.  Nevertheless  this 
instrument  itself  contained  the  assurance  that  "  all  debts  contracted, 
and  engagements  entered  into,  before  the  adoption  of  this  Consti- 
tution, shall  be  as  valid  against  the  United  States  under  this  Con- 
stitution as  under  the  Confederation"  (Article  VI,  First  Clause). 
That  no  mention  is  made  of  state  debts  is  not  to  be  wondered  at ;  it 
was  hardly  a  subject  for  treatment  in  such  a  brief  document  as  the 
National  Code.1  And  besides,  the  bulk  of  the  Revolutionary  War 
debt  of  the  states  had  been  assumed  by  the  Federal  Government. 

1  State  debt  was  indeed  touched  upon  nearly  a  century  later,  in  the  Fourteenth 
Amendment,  Section  4,  inhibiting  the  states  from  assuming  or  paying  obliga- 
tions incurred  in  aid  of  rebellion  against  the  United  States;  but  this  was 
passed  in  that  reactionary  period  when  the  cry  of  "  States  Rights  "  was  anything 
but  a  popular  slogan,  yet  was  inspired  not  so  much  by  opposition  to  state 
independence  in  fiscal  matters  as  by  desire  to  make  impossible  the  financing  of 
future  uprisings. 


124     STATE  BONDS:  THE  HISTORY  OF  STATE  DEBT 

However,  from  the  tenor  of  the  whole  Constitution,  particularly 
from  that  clause  of  the  First  Article  prohibiting  (he  states  from  the 
impairment  oT  the  obligation  of  contracts,  one  would  be  led  to  ex- 
pect an  integrity  in  financial  affairs  on  the  part  of  the  states,  safe- 
guarded by  law  and  by  constitution,  similar  to  that  national  in- 
tegrity  which  was  soon  achieved  and  has  since  been  preserved  almost 
without  interruption.    But  this  was  not  to  be  the  case. 

373.  In  1792  a  citizen  of  North  Carolina1  brought  suit  in  the 
Supreme  Court  of  the  United  States  against  the  State  of  Georgia, 
and  thus  raised  the  important  question, — again  involving  the  limits 
of  state  sovereignty, — as  to  whether  a  state  could  be  sued  by  an 
individual.  The  majority  of  the  Court  decided  in  the  affirmative, 
Mr.  Justice  Wilson  giving  the  opinion  and  Chief  Justice  Jay  support- 
ing. This  of  course  aroused  the  Anti-Federalists  and  resulted  four 
years  later  in  the  ratification  of  the  Eleventh  Amendment,  by  the 
terms  of  which: 

"The  judicial  power  of  the  United  States  shall  not  be  construed 
to  extend  to  any  suit  in  law  or  equity,  commenced  or  prosecuted 
against  any  of  the  United  States  by  citizens  of  another  state,  or  by 
citizens  or  subjects  of  any  foreign  state." 

It  is  possible  that  when  the  amendment  was  submitted  to  1he 
legislatures  of  the  states  for  ratification,  although  the  idea  of  state 
repudiation  was  wholly  foreign  to  the  spirit  of  the  times,  some 
pressure  was  brought  to  bear  in  the  interest  of  the  already  harassed 
tax-payers  who  feared  the  increased  burden  that  a  final  settlement 
of  the  many  unassumed  outstanding  war-claims  would  involve;  but, 
— to  repeat, — political  considerations  all  over  the  Union  were  para- 
mount at  the  time,  and  the  issue  was  the  logical  result,  rather  of 
hostility  toward  further  centralization  of  government  than  of  local 
resistance  to  the  tax-burden.2 

374.  Georgia,  naturally,  was  the  vortex  of  this  embroilment. 
Upon  the  decision  of  the  Supreme  Court  in  the  case  of  Chisholm  v. 

1  Chisholm  vs.  Georgia,  reported  in  2  Dallas. 

*  To  this  origin  Mr.  John  Hume,  in  his  well-known  articles  on  repudiation  in 
the  North  American  Review  (1884,  Vol.  139,  p.  564  and  elsewhere),  attributes 
the  Eleventh  Amendment,  and  by  manifest  implication  traces  the  subsequent 
evils  of  "  state  roguery."  Probably  he  got  his  suggestion  from  The  Nation  for 
January  31,  1878,  which  says,  "The  reason  for  engrafting  such  an  inconsistency 
upon  a  code  that  professes  '  to  establish  justice  '  among  men  and  communities 
was  the  embarrassed  condition  of  the  States  at  the  time  the  Federal  Union  was 
formed."  This  traditional  view,  widely  held  and  important  if  true,  is  contro- 
verted by  the  facts. 


STATE  BONDS:  THE  HISTORY  OF  STATE  DEBT      125 

Georgia,  the  legislature  prohibited,  on  pain  of  death,  any  attempt 
on  the  part  of  United  States  marshals  to  collect  the  judgment.  No 
state  would  then  have  proceeded  to  such  extremes  in  language  and 
measures  merely  in  the  interest  of  a  depleted  exchequer.  Nothing 
could  condone  such  a  course  except  encroachment  upon  a  cherished 
prerogative.  The  spirit  of  repudiation,  then,  does  not  date  back 
to  the  youth  of  the  Republic. 

375.  It  is  true  that  even  prior  to  the  agitation  in  1793  for  this 
amendment  Delaware  had  declared  in  her  second  constitution  that 
suits  might  be  brought  against  her.  It  is  true  also  that  in  179G, 
before  the  adoption  of  the  article,  Tennessee  had  granted  her  own 
citizens  the  same  right,  and  that  in  after  years,  as  the  feeling  in 
regard  to  state  sovereignty  became  less  tense,  seventeen  other  states 
incorporated  this  provision  in  their  revised  constitutions.  But  some 
of  the  seventeen  have  since  stricken  it  out,  only  five  1  have  passed 
supplemental  statutes  making  it  possible  to  enforce  the  provision, 
and  in  most,  if  not  all,  cases  the  wronged  bondholders  have  been 
brought  to  realize  that  it  is  one  thing  to  sue  an  unreceptive  state, 
under  its  own  laws,  before  its  own  judges,  and  another  thing  to 
seek  redress  before  disinterested  courts  deriving  their  authority 
from  the  National  Government  and  presided  over  by  officers  with 
life  tenure.2 

376.  Except  for  that  clause  of  the  Fourteenth  Amendment  dis- 
avowing all  obligations  incurred  in  aid  of  secession,  the  bearing  of 
constitutional  law  upon  the  subject  of  state  debt  ends  with  the 
Eleventh  Amendment.  The  misuse  that  has  subsequently  been  made 
of  the  Amendment  is  a  matter  for  further  study.  But  before  con- 
tinuing let  us  revert  once  more  to  our  classification.  We  now  know 
only  too  well  that  State  Bonds  are  analogous  to  Governments  proper 
and  in  contrast  to  Municipals  in  this  further  respect  that  there  is  no 
practical  remedy  at  law  against  their  default.  Since  both  are  the 
obligations  of  sovereign  powers,  we  must  turn  to  history  for  an 
adjustment  of  their  valuation  upon  a  basis  of  credit. 

377.  Debts  of  the  Commonwealths :  Default  and  Repudiation.  In  the 
early  years  of  the  Republic  the  American  people  were  exceedingly 

1  Indiana,  Wisconsin,  Nebraska,  Nevada,  and  Mississippi. 

3  Since  one  sovereign  state  may  sue  another,  a  holder  of  North  Carolina  bonds 
donated  $10,000  of  them  to  South  Dakota,  which  carried  the  case  to  the  United 
States  Supreme  Court  and  received  in  settlement  $27,410.  Based  on  this  suc- 
cess, attempts  have  been  made  to  persuade  New  York,  Michigan,  Rhode  Island, 
ana  Nevada  to  sue. 


120     STATE   BONDS:  THE  HISTORY  OF  STATE  DEBT 

careful  of  their  financial  standing.  As  we  have  said,  at  the  close  of 
the  War  of  Independence  the  Federal  Government  assumed,  for  a 
time,  the  larger  part  of  the  debts  of  the  thirteen  states.  It  was  no 
part  of  the  doctrine  of  Hamilton  and  his  Federalist  successors  that 
a  large  national  debt  was  a  public  blessing;  and  later,  under  the 
peace  administration  of  the  Republicans,  aided  by  the  wise  opera- 
tions of  Gallatin,  Hamilton's  policy  became  traditional  in  the  Treas- 
ury Department,  t<>  tlie  material  reduction  of  the  national  debt 
(see  §§  356,  357).  The  War  of  1812  of  course  postponed  for  years 
any  idea  of  its  immediate  extinction,  and  movements  toward  that 
end  were  again  retarded  by  the  financial  depression  of  1819-22,  par- 
ticularly because  the  fiscal  policy  of  the  Government  made  the 
Treasury  largely  dependent  for  revenues  on  import  duties.  But  with- 
out further  serious  setbacks  the  national  debt  gradually  dwindled 
away  and  was  finally  paid  off  in  1835. 

378.  Up  to  this  time  a  conservatism  had  been  displayed  by  the 
commonwealths  also.  In  1825  the  aggregate  outstanding  loans  of 
the  states  amounted  to  $13,000,000,*  or  $5,000,000  less  than  at  the 
time  of  national  assumption  in  1790.  By  1830  they  had  increased 
to  |2G,000,000,  and  by  1835,  the  year  of  the  extinction  of  the  national 
debt,  to  $46,000,000 ;  but  although  the  increase  was  in  greater  ratio 
by  far  than  the  increase  in  population,  and  somewhat  more  than 
the  increase  in  wealth, — all  three  being  assisted  by  great  industrial 
development  and  the  accession  of  new  states, — still  it  could  not  be 
called  excessive  or  alarming. 

379.  But  the  next  five  years  entirely  changed  the  status  of  things. 
In  this  lustrum  the  country  began  to  reap  what  it  had  sown.  In 
many  respects  the  seven  years  preceding  the  crisis  of  1837-38  found 
"  one  of  the  most  extraordinary  financial  periods — perhaps  the  most 
extraordinary  period — which  the  world  has  ever  seen."2  The  results 
of  a  general  Continental  peace  were  reflected  in  the  demand  for  our 
manufactures  and  in  the  growth  of  our  export  trade ;  the  seasons  had 
been  favorable  to  crops;  virgin  territory  had  been  opened  up  to 
agriculture  and  mining;  foreign  commerce  had  been  stimulated  by 
the  use  of  bills  of  exchange;  for  various  causes  connected  with 
national  banking  and  currency  laws,  state  and  local  banks  had 
rapidly  augmented  their  capitalization  and  deposits  and  conse- 
quently their  notes;  on  the  basis  of  this  inflated  currency  and  the 

1  Round  amounts  are  sufficient  for  the  purpose  in  hand.  The  exact  figures 
are   in    doubt. 

2  Hon.  B.  R.  Curtis,  North  American  Review,   1884. 


STATE  BONDS:  THE  HISTORY  OF  STATE  DEBT      127 

resultant  inflation  of  prices,  credit  became  unduly  extended,  and, 
to  use  the  familiar  but  appropriate  figure,  nothing  was  lacking  but 
a  first  occasion  to  puncture  the  financial  bubble. 

380.  It  is  not  surprising,  however,  to  one  at  all  conversant  with 
the  history  of  the  times,  that  these  same  conditions  which  made 
possible  the  extinction  of  the  national  debt  should  effect  an  opposite 
result  upon  state  debt.  These  causes  are  both  general  and  par- 
ticular. The  national  moral  consciousness  has  always  been  more 
sensitive  and  more  sober  than  that  of  the  constituencies.  There 
seems  to  be  a  close  connection  between  magnitude  and  integrity  in 
American  political  units.  This  truth  has  been  plainly  evident  in 
our  history  from  the  first  deliberations  of  the  Continental  Congress 
to  the  present  hour.  It  is  undoubtedly  inherent  in  the  peculiar 
composition  of  our  body  politic,  but  accentuated  by  local  causes, 
geographical,  ethnological,  and  historical,  which  will  in  time  disap- 
pear, and  are  even  now  disappearing  under  the  influence  of  assimi- 
lative processes.  This  national  moral  consciousness,  particularly 
well  represented  for  the  most  part  by  the  early  Presidents  and  by 
the  Secretaries  of  the  Treasury,  seized  upon  these  seven  fat  years 
beginning  before  1830  to  discharge  the  national  obligations  and  even 
to  distribute  surplus  revenues  to  the  states.  But  the  states  for  their 
part  saw  in  their  own  swelling  revenues  only  the  opportunity  to 
embark  in  speculative  enterprises  of  internal  improvement  upon 
such  a  vast  scale,  and  by  means  of  such  enormous  bond  issues, 
that  in  some  cases  a  tax  of  hundreds  of  dollars  per  capita  would 
have  been  necessary  to  liquidate  them. 

381.  Widespread  antagonism  toward  further  extension  of  the 
Federal  functions  undoubtedly  helped  preserve  the  Government  from 
the  same  temptation.  Undoubtedly  too  these  public  undertakings 
by  many  of  the  commonwealths  originated  in  perfectly  good  faith; 
not  honor,  but  sound  business  sense,  was  lacking.  Nowhere  is  the 
naive  speculative-patriotic  spirit  of  the  times,  as  it  affected  state 
debts,  more  aptly  illustrated  than  in  the  first  Constitution  of  the 
State  of  Michigan,  which  came  into  the  Union  in  1837,  at  the  cul- 
mination of  the  period  of  prosperity.  This  instrument  made  it  "  the 
duty  of  the  legislature,  as  soon  as  may  be,  to  make  provision  by 
law  for  ascertaining  the  proper  objects  for  improvement  in  rela- 
tion to  roads,  canals,  and  navigable  waters."  And  the  lesson  of 
the  seven  succeeding  lean  years  was  so  poorly  learned  and  quickly 
forgotten  that  Florida  entered  the  Union  in  1815  handicapped  by 


128     STATE   BONDS:  THE  HISTORY  OF  STATE  DEBT 

its  constitution  with  directions  to  its  General  Assembly  of  the  same 
purport  and  couched  in  almost  the  same  words. 

382.  It  is  not  so  easy  on  the  other  hand  to  realize  to-day  the 
extent  of  the  temptation  toward  extravagance  under  which  the 
states  labored.  Not  only  was  credit  to  be  had  for  the  asking,  but 
lack  of  the  most  elementary  improvements  was  general.  We  of 
to-day  who  talk  about  our  "  inadequate  transportation  facilities,"  to 
improve  which  we  permit  our  capitalists  to  bond  public  utilities  for 
double  their  first  cost,  should  remember  this  in  considering  the  public 
expenditures  for  railroad  ownership  and  aid  in  the  thirties;  and 
however  we  deplore  the  infelicities  of  our  present  systems  of  currency 
and  banking  and  their  inadequacy  to  cope  with  financial  crises,  we 
should  remember  the  heavier  burden  borne  by  our  predecessors  in 
the  repeated  cessation  of  payment  in  specie  and  the  inevitable  de- 
preciation of  the  currency. 

383.  Yet  when  all  allowances  are  made  with  understanding  and 
sympathy,  the  fact  remains  that  in  1836  the  United  States  had  paid 
off  its  funded  debt,  and  for  some  years,  in  face  of  the  times,  strove 
to  keep  free  from  foreign  obligations ;  whereas  the  aggregate  debt  of 
the  states,  which  in  1835  we  found  to  be  $46,000,000,  grew  in  the 
next  three  years  to  $175,000,000 ! 

384.  There  was  no  one  section  of  the  country  conspicuously  in- 
fected by  this  debt-making  fever,  although,  in  the  light  of  subse- 
quent events,  we  are  accustomed  to  refer  vaguely  to  "  the  West  and 
South."  New  England  to  be  sure,  the  most  mature  large  geographi- 
cal division  of  the  country,  always  conservative,  and  in  less  need  of 
material  exploitation  and  social  advancement,  at  this  time  withheld 
itself  for  the  most  part  from  bond  issues.  Maine,  parted  from 
Massachusetts  in  1820,  assumed,  without  question,  one-third  of  the 
Massachusetts  debt,  though  by  no  means  possessing  one-third  of  the 
territorial  resources  of  the  original  undivided  unit. — and  in  so 
doing  set  a  praiseworthy  precedent  that  West  Virginia,  created  of 
her  own  volition  after  and  as  a  result  of  the  Civil  War,  with  one- 
third  of  the  territory  of  old  Virginia  and  more  than  one-third  of 
the  resources,  has  not  seen  fit  to  follow.1  Maine's  debt  thereafter 
was  slowly  reduced,  partly  with  the  help  of  indemnity  money  from 

1  On  March  6,  1911,  after  a  controversy  before  the  courts  of  Virginia  and 
the  Federal  Government  almost  as  long  as  the  famous  Jarndyce  vs.  Jarndyce 
case  was  in  chancery,  the  United  States  Supreme  Court  adjudged  that  the  State 
of  West  Virginia  was  equitably  obliged  to  pay  $7,182,507  of  the  debt  of  the  old 
State  of  Virginia.    The  amount  of  interest  will  probably  be  adjusted  by  a  master. 


STATE  BONDS:  THE  HISTORY  OF  STATE  DEBT      129 

Great  Britain,  and  has  never  since  been  an  object  of  serious  con- 
cern to  her  people.  New  Hampshire,  with  credit  as  solid  and  endur- 
ing as  her  rock-bound  hills,  always  was,  and  now  is,  loath  to  incur 
debt.  The  difficulties  of  the  late  thirties  were  scarcely  felt  by  New 
Hampshire  and  no  bonds  or  stock  were  outstanding  from  that  time 
till  the  War  of  '61.  Vermont  had  no  debt  till  1859;  Connecticut 
and  Rhode  Island,  no  debt  from  the  Revolution  till  the  Civil  War. 
Of  all  the  New  England  states,  Massachusetts,  aware  of  her  own  re- 
sources and  power,  then  as  now,  was  the  only  commonwealth  some- 
what profuse  in  creation  of  indebtedness.  How  history  repeats 
itself! 

385.  The  Middle  Atlantic  states  had  no  such  reticence.  New  Jersey 
indeed  did  not  bond  herself  before  1838,  and  in  her  constitution  of 
1842  set  an  early  and  desirable  example  by  limiting  the  debt  to  $100,- 
000,  with  the  now  common  exception  for  purposes  of  war,  etc.,  as  the 
result  of  which  her  conservative  fiscal  policy  has  been  more  in  align- 
ment with  that  of  the  New  England  states  than  with  that  of  her 
neighbors;  and  Delaware,  too,  with  no  debt  at  all  prior  to  the  War 
and  none  since  worth  considering,  should  be  favorably  mentioned. 
But  New  York,  Pennsylvania,  and  Maryland,  although  acquitted  on 
the  score  of  honor,  acted  in  those  troublesome,  debt-incurring  times 
with  an  unwisdom  forgotten  only  because  retrieved.  The  causes  for 
all  three  were  about  the  same:  the  financing  of  needed  canal  construc- 
tion and  improvement,  and  the  aiding  of  the  railroads.  A  beginning 
was  made  in  moderation,  and  then,  when  enthusiasm  had  been 
aroused  and  discretion  thrown  to  the  winds,  a  riot  of  contractual 
obligations  was  entered  into  with  much  anticipation  of  what  the 
money  raised  was  to  be  spent  for,  and  little  of  how  it  was  to  be  re- 
paid. 

386.  The  history  of  New  York's  state  debt  is  too  well  known  to 
require  much  comment.  Although  the  burden  in  the  early  forties 
was  critically  large,  the  Empire  State  always  managed  to  take  care 
of  principal  and  interest  when  due.  It  is  not  so  well  known,  if 
indeed  it  has  not  generally  been  forgotten,  that  both  Pennsylvania 
and  Maryland  had  to  suffer  the  shame  of  temporary  default.  Both 
were  compelled  to  stop  the  payment  of  interest  in  1842,  owing  par- 
ticularly to  state  construction  of  canals,  and  to  the  abolition  of 
direct  taxation  during  the  hard  times  preceding.  Pennsylvania  re- 
sumed payments  in  1845  in  "  relief  notes,"  which  then  were  the  state 
currency;  they  were  speedily  retired.  Maryland  had  made  up  all 
delinquent  interest  by  1848.    The  majority  of  her  citizens  acted  dur- 


130     STATE  BONDS:  THE  HISTORY  OF  STATE  DEBT 

ing  these  years  in  good  faith,  although  the  body  of  those  dishonor- 
ably inclined  rose  to  the  dignity  or  indignity  of  a  Repudiation  Party. 
In  1837  Maryland  had  paid  her  debt  interest  in  gold,  as  did  Massa- 
chusetts during  the  Civil  War, — and  both  at  times  when  the  banks 
had  suspended  specie  payment. 

387.  Although  debt  history  in  the  depression  of  1837-45  cannot 
be  geographically  divided,  it  was  inevitable  that  the  less  developed 
West  and  South  should  suffer  more  than  the  East,  and  that  the  re- 
sult should  be  written  in  financial  history.  It  is  for  us  to  consider, 
however,  whether  the  West  and  South,  in  whole  or  in  part,  both  in 
this  depression  and  in  those  subsequent  to  it,  maintained  that  sort 
of  financial  integrity  which,  in  spite  of  temporary  reverses  of  for- 
tune, gives  to  a  nation,  a  municipality,  a  firm  or  an  individual,  a 
credit  that  is  worth  as  much  to  the  holders  of  the  debtor's  paper 
as  the  realizable  assets  itemized  upon  the  treasurer's  books. 

388.  The  First  Repudiation  Period.  It  is  hardly  necessary  to  say 
that  Pennsylvania  and  Maryland  were  not  the  only  states  to  default 
for  a  time  in  the  seven  lean  years  following  1837.  Indiana,  in  1840, 
Illinois,  in  1841,  Michigan,  Florida,  and  Mississippi,  in  1842,  did 
likewise.  This  is  not  only  the  ordinary  geographical  order,  and  the 
temporal  as  well,  but  it  marks  perfectly  the  degree  of  obliquity  in- 
volved. Of  the  four  Northern  states,  only  the  last,  Michigan,  did 
not  reimburse  all  creditors  to  the  full.  Michigan  acknowledged  and 
acquitted  her  obligations  on  all  bonds  for  which  she  had  obtained 
payment,  irrespective  of  any  benefits  received  from  the  money;  but 
on  such  as  she  had  obtained  only  part  payment  she  acquitted  the 
debt  only  in  that  part,  even  though  title  had  passed  to  innocent 
holders.  Of  this  entire  list  of  seven  defaulting  states  only  the  last 
two,  Mississippi  and  Florida,  were  of  the  South,  and  only  the  last 
two,  Mississippi  and  Florida,  were  guilty  of  deliberate  repudiation, 
and  of  these  two,  Mississippi  repudiated  twice  before  the  Civil  War, 
and  Florida  once  in  each  repudiation  period. 

389.  We  are  concerned  in  this  recital  only  with  the  history  of 
state  debts  as  it  has  a  bearing  upon  state  credit.  It  is  to  be  hoped 
that  in  the  study  of  history  we  may  reach  some  broad  and  jus- 
tifiable conclusions  pertinent  to  the  purchase  of  state  bonds.  We 
shall  show  that  on  these  grounds  it  is  legitimate  to  pass  lightly 
over  the  defaults  of  the  Northern  states.  To  be  sure  almost  every 
default,  irrespective  of  time  or  locality,  arose  out  of  conditions  that 
will  never  be  met  again  in  this  country.  Default  was  the  result  of 
an  unwise  zeal  to  hasten  by  arbitrary  legislation,  and,  for  the  most 


STATE  BONDS:  THE  HISTORY  OF  STATE  DEBT      131 

part,  in  undeveloped  territory,  the  spread  of  material  progress  and 
the  slow  growth  of  institutions.  And  so,  successively  in  the  East, 
the  South,  and  the  West,  it  was  the  same  story:  state  ownership 
of,  or  aid  for  canals,  railroads,  turnpikes,  banks,  and  eleemosynary 
and  educational  institutions.  But  there  is  this  all-important  dif- 
ference to  the  ending  of  the  tale:  barring  Minnesota  in  war  time, 
the  North  paid  its  debts  and  the  South  shirked  them. 

390.  These  states  we  have  mentioned  were  not  the  only  common- 
wealths in  serious  difficulties.  Ohio,  in  the  North,  was  one  of  the 
earliest  to  contract  debts  for  extensive  internal  improvements, 
placing  a  foreign  loan  for  canal  and  railroad  purposes  as  early  as 
1825.  The  maximum  amount  of  her  debt,  reached  in  1845  (a  total 
of  over  $19,000,000),  was  a  very  heavy  load  to  carry  in  those  days; 
but  before  it  was  too  late  the  state  came  to  her  senses,  and  in  the 
new  constitution  of  1851,  prohibited  further  aid  for  public  improve- 
ments. 

391.  At  about  the  same  period  Alabama,  in  the  South,  laid  her- 
self open  to  financial  ills  by  subscribing  to  the  stock  of  the  state 
bank  and  its  branches  to  the  extent  of  some  $8,000,000.  Relying 
on  the  income  of  this  stock,  like  Pennsylvania  she  abolished  direct 
taxation, — in  1836.  When  as  the  result  of  the  suspension  of  specie 
payment  the  bank  became  insolvent  in  1842,  the  state  avoided  default 
during  the  ante-bellum  period  only  by  resort  to  now  doubly  burden- 
some taxation.  Since  the  intent  of  these  two  states  at  that  time 
was  honorable,  but  their  financing  only  a  little  less  hazardous  than 
that  of  the  defaulting  but  non-repudiating  Northern  states,  there  is 
no  reason  for  discriminating  against  the  former  or  in  favor  of  the 
latter  because  of  a  brief  and  unavoidable  suspension  of  interest 
payments. 

392.  On  the  other  hand  it  is  but  just  to  mention  the  two  other 
Northern  states,  Wisconsin  and  Iowa,  which,  organized  as  terri- 
tories and  admitted  into  the  Union  during  the  times  of  which  we 
write,  had  to  look  as  far  as  the  Atlantic  seaboard,  either  before  or 
after  the  Civil  War,  to  find  their  fellows  in  reluctance  to  incur  in- 
debtedness or  in  preparedness  to  discharge  it.  All  other  states  of 
the  Union  which  we  have  not  mentioned  or  shall  not  mention  in  this 
connection  are  clear  of  the  charge  of  fiscal  folly  or  dishonor,  but 
all  such  states  came  into  the  Union  after  the  War. 

393.  If  the  conduct  of  the  five  Northern  states  which  defaulted 
in  the  forties,  and  of  other  non-defaulting  states  in  both  North  and 
South,  was  indiscreet  to  the  point  of  foolhardiness,  it  was  not  dis- 


132     STATE  BONDS:  THE  HISTORY  OF  STATE  DEBT 

honorable.  Undoubtedly  even  Michigan  felt  she  was  discharging 
her  full  moral  obligation  in  refunding  only  that  part  of  the  issues 
for  which  she  had  been  paid.  But  the  conduct  of  the  two  Southern 
states  that  repudiated  had  no  justification  in  ethics,  if  i(  had  in 
law.  The  Governor  of  Mississippi,  replying  in  July,  1841,  to  a  letter 
from  Hope  and  Co.,  of  Amsterdam,  who  represented  a  large  num- 
ber of  holders  of  the  Union  Bank  bonds,  made  a  brave  show  of 
five  causes  of  unconstitutionality  in  the  issue,1  and  Jefferson  Davis, 
in  the  following  month,  with  less  logic  and  more  Southron  elo- 
quence, abetted  the  course,2  and  the  people  by  their  subsequent 
elections  to  the  legislature  approved  of  the  repudiation  of  the  Union 
Bank  bonds.  In  1852  Mississippi  made  perfectly  plain  whether 
invalidity  was  the  ultimate  cause  by  repudiating  by  popular  vote 
the  Planters'  Bank  bonds  on  which  there  was  not  the  slightest 
shadow  of  invalidity.'' 

394.  Florida  raised  the  excuse  of  invalidity  on  both  occasions 
when  it  became  convenient  to  withhold  moneys  due.  The  state  had 
better  grounds  for  default  than  Mississippi  in  actual  inability  to 
meet  her  obligations  in  full ;  but  her  two  expedients  to  escape  pay- 
ment were  much  more  pernicious  as  precedents,  for  the  first  was  based 
upon  the  principle  that  a  state  on  being  admitted  into  the  Union 
might  be  absolved  under  certain  circumstances  from  financial  cove- 
nants entered  into  by  Congressional  enactment  when  a  territory,  and 
the  second  upon  the  tacit  understanding  that  the  state  courts  were 
justified  in  returning  interpretations  and  decisions  biased  to  the 
popular  will.  Even  Mississippi  had  not  gone  so  far;  repudiation 
there  had  met  some  opposition  in  the  courts. 

Before  coming  to  the  later  repudiation  period  certain  war-time 
cases  are  to  be  noted. 

395.  War-Time  Repudiation  and  Default.  In  1860  the  legislature 
of  Minnesota,  following  the  will  of  the  people,  adopted  an  amend- 
ment to  the  constitution,  forbidding  the  payment  of  principal  or 
interest  (except  after  a  referendum)  of  the  bonds  issued  in  aid  of 
the  railroads.  This  was  popular  repudiation  pure  and  simple,  and 
utterly  inexcusable  because  utterly  unnecessary.  The  people  in- 
deed suspected  with  reason  that  fraud  had  been  perpetrated  upon 
them,  just  as  the  people  of  the  South  did  after  the  Civil  War.  In 
Minnesota's  case,  however,  the  proved  instances  were  not  flagrant 

1  Bankers'  Magazine,  November,  1849,  p.  345  et  seq. 

2  Ibid.,  p.  363  et  seq. 
•Scott,  Repudiation  of  State  Debts,  New  York,  1893,    (out  of  print),  p.  42. 

0  rA 


STATE  BONDS:  THE  HISTORY  OF  STATE  DEBT      133 

enough  to  be  submitted  in  extenuation.  The  significance  in  this 
Northern  state  is  that  the  ghost  of  repudiation  would  not  down. 
Time  after  time  that  matter  was  brought  before  the  people  in  one 
form  or  another,  by  the  bondholders,  the  legislators,  and  the  gov- 
ernors, and  finally  after  an  agitation  continuing  off  and  on  for 
twenty  years  the  State  Supreme  Court  decided  that  the  Amend- 
ment of  1860  was  unconstitutional,  and  in  1881  the  legislature 
passed  a  refunding  act,  compromising  the  old  bonds  at  fifty  cents 
on  the  dollar,  but  with  accrued  interest.  That  the  people  of 
Minnesota  should  for  so  long  have  been  morally  more  obtuse  than 
their  agents  and  representatives  is  best  explained  by  recalling  the 
primitive  condition  of  the  state  and  its  inhabitants  at  that  time. 

396.  There  is  little  more  of  vital  interest  to  state  debt  to  chronicle 
till  1870.  It  seems,  however,  to  have  escaped  general  notice  by 
historians  of  American  finance  that  as  the  immediate  result  of  the 
War,  Missouri  was  at  one  time  heavily  in  arrears  in  interest  on 
her  debt,  and  that  therefore  it  is  with  questionable  legal  right  that 
the  bonds  of  Missouri  cities  are  owned  by  savings  banks  in  certain 
states.  In  1865  the  amount  was  $5,000,000,  but  thereafter  was 
rapidly  reduced.  During  the  war  Alabama  paid  the  interest  upon 
that  portion  of  the  debt  we  have  mentioned  which  was  held  in 
London.  This  was  possible  and  politic  as  her  ports  were  open.  Of 
course  interest  was  defaulted  on  the  portion  held  in  the  North.  In 
1865  all  interest  ceased.  Alabama's  subsequent  troubles  were  due 
to  the  enactment  of  laws  authorizing  what  may  be  called  blanket 
indorsement,  by  the  state,  of  railroad  bonds  upon  a  mileage  basis. 
The  amount  of  business  folly  concentrated  in  these  acts  is  probably 
greater  than  in  any  hitherto  perpetrated  by  a  state  legislature,  yet 
the  default  and  repudiation  which  followed  as  a  matter  of  course 
were  the  most  excusable  of  any  because  the  state  was  sincere  in  its 
endeavor  to  meet  its  obligations.  The  Funding  Act  of  1876  by 
which  it  scaled  its  obligations  about  50  per  cent,  closed  this  un- 
fortunate period  of  its  career. 

397.  The  Second  Repudiation  Period.  The  second  or  reconstruction 
period  of  repudiation  which  we  have  now  entered  lasted  from  1870  to 
1884.  During  it  nine  states,  all  in  the  South,  sought  relief  from  theif 
debts  by  repudiation: — Virginia,  North  Carolina,  South  Carolina, 
Georgia,  Florida,  Alabama,  Louisiana,  Arkansas,  and  Tennessee.  To 
these  some  would  add  West  Virginia,  which  has  taken  a  repudiative 
attitude  toward  whatever  is  her  just  portion  of  the  old  Virginia 
debt.    No  satisfactory  dates  can  be  furnished  as  in  the  first  period 


134     STATE  BONDS:  THE  HISTORY  OF  STATE  DEBT 

because  in  most  cases  defaults  were  so  frequent.  In  some 
of  the  states,  e.g.  North  Carolina,  defaults  around  1870  on  some 
fresh  portion  of  interest  or  principal  were  almost  annual  occur- 
rences. 

398.  It  is  hardly  necessary  to  say  that  the  hardships  of  the  war 
were  reflected  in  the  state  debts.  Of  course  the  bonds  of  the  Con- 
federate States  and  the  bonds  of  the  seceding  states  issued  for  the 
purposes  of  the  war  were  void.1  Therefore  the  new  debt  burden  of 
the  South  was  not  a  direct,  but  an  indirect  result  of  the  war.  It 
was  due  particularly  to  the  incompetence,  extravagance,  and  ras- 
cality of  the  Northern  war-governors  and  the  black-Republican  legis- 
latures of  their  creating,  and  generally  to  the  fact  that  the  South 
had  committed  itself,  even  more  deeply  than  the  North,  to  the 
policy  of  railroad  aid,  both  before  and  after  the  war.  The  accumu- 
lation of  interest  unpaid  during  and  after  the  war  was  also  a  very 
heavy  charge.  From  these  various  causes  and  some  others,  the  debt 
of  the  repudiating  Southern  states,  which  in  1SG0  was  $87,707,090, 
had  reached  in  1870  the  total  of  $170,025,340,  an  increase  of  $82,- 
257,650,  or  94  per  cent. 

399.  While  the  funded  obligations  and  in  turn  the  annual  tax 
burdens  were  thus  increasing  the  ability  of  the  states  to  meet  them 
grew  correspondingly  less ;  for  the  assessors'  value  of  taxable  prop- 
erty (both  real  and  personal,  including  slaves  in  the  first  period), 
which  in  1860  was  $4,065,965,607,  had  declined  in  1870  to 
$2,014,614,448,  a  loss  of  $2,951,351,150,  or  52  per  cent.  Furthermore, 
in  the  prostration  of  the  decade  following  the  war  the  railroads, 
upon  which  the  people  had  fondly  relied  to  take  care  of  such  a  large 
portion  of  the  interest,  were  unable  to  meet  their  charges,  and  this 
source  of  anticipated  revenue  for  railroad  aid  and  state  guaranteed 
bonds  was  almost  entirely  cut  off. 

400.  The  TJltimate  Cause  of  Repudiation.  If  now,  wTith  the  two 
periods  of  default  and  repudiation,  thus  roughly  sketched,  before 
us,  we  seek  the  main  underlying  weakness  in  state  credit,  we  have  not 
far  to  look.  In  the  first  place  a  careful  distinction  should  be 
made  between  unavoidable  default  and  general  repudiation.  The 
former  evil  was  more  prevalent  in  the  first  period  and  the  latter 
during  the  second.  In  so  far  as  default  by  a  state  was  unavoid- 
able, and  subsequently  redeemed,  it  has  no  bearing  upon  future 
state  credit  because  it  was  the  outcome  of  transitory  financial  con- 
ditions.   As  to  wilful  repudiation  it  is  a  curious  fact  that,  with  the 

1  By  the  Fourteenth  Amendment. 


STATE  BONDS:  THE  HISTORY  OF  STATE  DEBT      135 

exception  noted  in  the  case  of  Mississippi,  and  in  one  or  two  others, 
all  efforts  on  the  part  of  states  to  avoid  payment  of  outstanding 
bonds  has  been  on  the  score  of  illegality  of  some  sort  or  other. 
In  connection  with  this  fact  and  in  significant  commentary  on  it, 
two  others  should  be  noted:  first,  that  the  dates  of  issue  of  the 
three  hundred  and  odd  millions  of  repudiated  bonds  do  not  fall 
in  definite  periods;  but,  second,  that  the  dates  of  the  acts  of 
repudiation  fall  for  the  most  part  within  the  two  periods  outlined. 
Illegality,  or  invalidity,  therefore  is  a  pretext,  or  rather  a  con- 
venient refuge,  which  ordinarily  will  not  be  resorted  to,  but  only 
under  the  urgency  of  extreme  material  or  moral  impoverishment, 
or  both. 

401.  This  brief  explanation  leaves  two  facts  unaccounted  for: 
that  the  South  did  not  default  to  the  extent  that  the  North  did  in 
the  first  period;  and,  that  in  both  periods  repudiation  was  the 
characteristic  source  of  relief  in  the  South. 

402.  Although  the  liabilities  of  the  repudiating  Southern  states 
were  doubled  and  the  resources  were  halved  in  the  decade  1860- 
1870,  it  would  be  difficult  to  prove  that  the  South  had  retrogressed 
during  this  period  in  purely  material  well-being  any  more  than 
the  North  and  Middle  West  in  the  seven  lean  years  following  1836. 
During  that  earlier  period  of  distress  the  South  had  been  engrossed 
in  agricultural  pursuits,  had  lived  very  close  to  the  soil,  and  had 
given  less  political  attention  to  those  public  works  of  improve- 
ment that  benefited  the  people  at  large  rather  than  the  dominant 
classes.  Therefore  the  South  had  not  felt  the  earlier  trial  in  its 
full  severity.  But  when  after  the  war  and  with  the  passing  of  the 
old  plantation  life  the  South  sought  to  stimulate  mercantile  and 
manufacturing  interests  by  those  very  artificial  devices  of  railroad 
— and  banking — aid  which  had  previously  proved  the  source  of  such 
disaster  in  the  North,  she  laid  herself  open  to  the  full  effects  of 
the  more  insidious  temptations  which  the  politics  of  the  Recon- 
struction Period  offered.  And  when,  in  addition  to  this,  she  came 
to  realize  in  defeat  the  loss  she  had  suffered  of  those  dearly  cher- 
ished attributes  of  state  sovereignty  that  were  particularly  South- 
ern, it  is  not  surprising  that  moral  disintegration  followed.  It 
would  be  hard  to  find  in  history  a  stronger  combination  of  cir- 
cumstances at  work  undermining  a  state's  financial  integrity. 

403.  But  even  this  explanation  is  not  sufficient  to  account  for 
the  conduct  of  Mississippi  and  Florida  in  the  ante-bellum  period, 
and  for  the  very  low  order  of  business  ethics   revealed   in  the 


13G     STATE  BONDS:  THE  HISTORY  OF  STATE  DEBT 

speeches  and  correspondence  of  leading  Southerners  and  in  the 
minutes  of  Southern  slate  conventions  both  before  and  after  the 
war.  In  this  connection  Mr.  Justice  Curtis  has  been  aptly  quoted,1 
and  the  passage  warrants  repeating.  Speaking  of  the  repudiation 
of  Mississippi  he  says: 

"  An  intelligent  foreigner,  who  feels  a  just  indignation  when  he  hears  of 
repudiation,  probably  knows  the  difference  between  a  Highland  Chieftain  and 
a  London  Merchant,  but  is  ignorant  that  differences  quite  as  great  exist  between 
the  people  of  Mississippi  and  the  people  of  Massachusetts.  Probably  there  are 
few  points  in  which  these  differences  would  be  so  likely  to  be  exhibited  as  upon 
the  matter  of  paying  debts.  To  pay  debts  punctually  is  the  point  of  honor 
among  commercial  peoples.  But  the  planters  of  Mississippi  do  not  so  esteem 
it.  They  do  not  feel  the  importance  of  an  exact  conformity  to  contracts.  It 
has  not  been  their  habit  to  meet  their  engagements  on  the  very  day  if  not  quite 
convenient.  Certainly  they  attach  no  idea  of  dishonesty  to  such  a  course  of 
dealing.  They  mean  to  pay,  but  they  did  not  expect  when  they  contracted  the 
debt  to  distress  themselves  about  the  payment.  If  a  friend  wants  a  thousand 
dollars  for  a  loan  or  a  gift,  he  can  have  it,  though  perhaps  a  creditor  wants 
it  also.  We  do  not  mean  to  intimate  that  there  are  no  high  qualities  in  such 
a  character,  but  they  are  different  from  those  which  make  good  bankers  or 
merchants;  and  therefore  bankers  and  merchants  ought  not  to  expect  such  men 
to  look  at  a  debt  just  as  they  do." 

If  this  racial  distinction  in  business  ethics  between  the  North 
and  the  South  has  been  better  put  elsewhere  we  have  not  seen 
it.  Prof.  Scott,  who  quotes  the  passage  in  his  work  just  men- 
tioned in  the  footnote,  remarks  that  this  comment,  written  in 
1844,  should  be  given  more  weight  in  explanation  of  the  repudia- 
tion acts  during  the  first  period  than  of  those  after  the  war  when 
a  commercial  spirit  had  been  awakened  in  the  South;  and  that  is 
true.  But  it  takes  more  than  one  or  two  generations  born  under 
a  new  dispensation  wholly  to  eradicate  racial  characteristics  as 
deep-seated  as  this.  An  illustration  will  presently  offer.  Mean- 
while it  is  sufficient  to  observe  that  the  perpetuity  of  tendencies  is 
to  be  as  implicitly  expected  in  financial  as  in  other  affairs.  The 
application  of  this  truth  to  railways  (and  railway  bonds)  is  made 
by  Carl  Snyder  in  his  American  Railways  as  Investments.    He  says : 

"  The  law  of  heredity,  so  strong  in  the  common  affairs  of  life,  obtains  in  some 
sense  among  railroads  also.  It  is  not  for  nothing  that  the  Vanderbilt  lines  have 
been  under  control  of  a  single  family  for  more  than  half  a  century.     It  is  not  for 

1  Original  article  in  North  American  Review,  January,  1844;  extract  in  Scott, 
Repudiation  of  State  Debts,  d.  234. 


STATE  BONDS:  THE  HISTORY  OF  STATE  DEBT      137 

nothing  that  the  Pennsylvania  has  never  failed  to  pay  a  dividend  for  more 
than  fifty  years.  It  is  not  for  nothing  that  roads  like  the  Reading,  the  Erie,  the 
Union  Pacific,  have  been  the  footballs  of  stock-jobbing  speculators  and  dishon- 
est directors.  The  ownership  of  a  road,  the  personnel  of  its  management,  may 
change  absolutely,  yet  it  is  curious  to  note  how  amid  all  these  changes  its  char- 
acter for  evil  will  sometimes  survive." 

And  if  this  is  the  case  with  the  railroad,  developing  amid  adven- 
titious influences,  to  what  greater  degree  in  the  state,  with  its 
more  settled  institutions  and  its  more  stable  polity! 

404.  The  ultimate  cause  of  state  repudiation,  then,  is  a  low  stand- 
ard of  business  ethics.  This  low  standard  in  a  broad  and  general 
way  may  be  said  to  be  a  racial  characteristic,  and  eradicable  only 
as  the  race  changes,  by  process  of  fusion  with  immigrant  popula- 
tion or  otherwise;  but  its  ill  effects  will  rise  to  the  height  of  dis- 
turbing state  credit  only  when  the  pressure  of  the  debt  burden  be- 
comes distressing.  And  it  is  very  probable  that  this  burden  will 
never  again  be  intolerable  in  any  of  our  states. 


CHAPTER  XIV 

STATE   BONDS:   THE   ELEMENTS   OF   SECURITY 

Security:  Intangible  Assets 

405.  When  considering  United  States  Bonds  in  a  preceding 
chapter  the  question  of  security  was  taken  for  granted  to  a  large 
extent, — these  bonds  being  by  common  consent  the  safest  form  of 
security  investment  in  America.  In  the  present  chapter  security 
is  the  main  theme,  because  there  can  be  no  general  reason  for 
preferring  state  bonds  to  municipals  unless  they  can  be  bought  with 
greater  safety.  And  since  there  is  no  practical  remedy  at  law 
for  their  default,  nor  (with  minor  exceptions)  any  sort  of  recourse 
to  property  in  satisfaction  of  just  claims,  the  emphasis  of  this 
chapter  is  upon  those  intangible  assets  of  the  state  that  are  the 
chief  inspiration  of  its  credit. 

406.  The  Gauge  of  State  Credit.  The  credit  of  a  municipality 
in  this  country  may  be  estimated  with  reasonable  correctness,  by 
those  not  in  a  position  otherwise  to  know,  from  the  market  value 
of  its  bonds,  expressed  in  income  yield.  The  yearly  flotation  of 
municipal  issues,  amounting  in  value  to  hundreds  of  millions  of 
dollars,  is  so  free,  and  the  demand  from  vested  interests  so  intelli- 
gent and  steady,  that  one  cannot  go  far  astray  who  uses  the  gauge 
of  credit  that  is  measured  by  percentage  of  income  from  the  in- 
vestment. Concretely,  the  security  behind  a  Municipal  yielding 
3i  per  cent,  is  to  be  presumed  greater  than  that  behind  a  Municipal 
yielding  4  per  cent.  There  is  no  such  free  market  by  which  to 
judge  (lie  credit  of  state  bonds,  as  we  shall  observe  later,  so  that 
it  is  necessary  for  the  investor  to  acquaint  himself  at  first  hand 
with  the  factors  that   make  for  state  credit. 

407.  The  Lesson  from  History.  The  payment  of  loans  to  the 
sovereign  depends  on  the  will  of  the  Sovereign;  the  will  of  the 
Sovereign  is  known  only  by  past  and  present  acts.  We  have  ex- 
amined the  debt  history  of  the  states  and  have  found  it  anything 

138 


STATE  BONDS:  THE  ELEMENTS  OF  SECURITY       139 

but  reassuring.  Yet,  so  far  as  history  is  concerned,  there  is  justifi- 
cation for  placing  the  same  confidence  in  the  bonds  of  certain  states 
that  we  do  in  the  federal  funds. 

408.  In  the  nature  of  the  case,  however,  the  power  of  discrimina- 
tion based  on  the  teachings  of  history  is  wanting  in  many  bond 
buyers  who  may  in  other  respects  have  a  nice  sense  of  investment 
values.  These  persons  through  lack  of  that  range  of  vision  which 
historical  training  encourages,  are  wont  to  consider  state  credit  in 
its  present  legal  and  material  aspects  only.  They  may  make  the 
mistake  of  approaching  all  classes  of  securities  by  the  same  road. 
But  this  is  not  best;  for  industrial  bonds,  to  illustrate,  should  be 
studied  intensively;  but  state  and  equipment  bonds  extensively. 

409.  History,  measured  by  events,  is  rapid  in  the  making,  and 
new  epochs  of  good  and  ill  press  hard  upon  one  another.  In  times 
of  national  prosperity  a  people  so  naturally  optimistic  as  Ameri- 
cans grow  forgetful ;  they  overestimate  their  own  qualities  and  re- 
sources and  become  oblivious  to  former  reverses.  Thus  are  created 
the  regularly  recurring  industrial  cycles, — more  severe  in  this 
country  than  elsewhere.  In  the  matter  of  state  debts,  therefore,  it 
is  best  to  be  open  minded.  Who  can  tell  what  reverses  in  fiscal 
policy  a  generation  may  bring  forth? 

410.  When  in  1839,  during  that  long  depression  of  the  first 
repudiation  period,  Baring  Bros,  of  London  inquired  of  Daniel 
Webster  concerning  "  the  measure  of  security  which  the  purchasers 
of  bonds  issued  by  the  states  of  the  American  Union  would  have 
for  their  investment,"  he  wrote  in  reply : 

"  The  states  cannot  rid  themselves  of  their  obligations  otherwise  than  by  the 
honest  payment  of  their  debts  .  .  .  they  possess  all  adequate  powers  of  pro- 
viding for  the  case,  by  taxes  and  internal  means  of  revenue.  They  cannot  get 
round  the  duty,  nor  evade  its  force.  Any  failure  to  fulfil  its  undertakings  would 
be  an  open  violation  of  public  faith,  to  be  followed  by  the  penalty  of  dishonor 
and  disgrace;  a  penalty,  it  may  be  presumed,  which  no  state  of  the  American 
Union  would  be  likely  to  incur.  ...  I  hope  I  may  be  justified  by  existing  cir- 
cumstances in  closing  this  letter  with  the  expression  of  an  opinion  of  a  more 
general  nature.  It  is,  that  I  believe  that  the  citizens  of  the  United  States,  like 
all  honest  men,  regard  debts,  whether  public  or  private,  and  whether  existing 
at  home  or  abroad,  to  be  of  moral  as  well  as  of  legal  obligation;  and  I  trust  that  I 
may  appeal  to  their  history,  from  the  moment  when  those  states  took  their 
rank  among  the  nations  of  the  Earth  to  the  present  time,  for  proof  that  this 
belief  is  well  founded.  If  it  were  possible  that  any  one  of  the  states  should,  at 
any  time,  so  entirely  lose  her  self-respect,  and  forget  her  duty  as  to  violate  the 
faith  solemnly  pledged  for  her  pecuniary  engagements,  I  believe  there  is  no 
country  upon  Earth — not  even  that  of  the   injured   creditor — in  which   such   a 


140       STATE  BONDS:  THE  ELEMENTS  OF  SECURITY 

proceeding  would  meet  with  less  countenance  or  indulgence  than  it  would  receive 
from  the  great  mass  of  the  American  people."  ■ 

Yet  within  two  years  Governor  McNutt  of  Mississippi  had  recom- 
mended, and  within  three  years  the  legislatures  of  Mississippi  and 
Florida  had  voted,  the  repudiation  of  nearly  $9,000,000  of  bonds. 

411.  In  view  of  the  fact  that  state  indebtedness  had  doubled 
since  1835,  it  is  not  surprising  that  London,  which  had  taken  a 
large,  if  not  the  largest  part  of  these  securities,  should  have  become 
anxious  regarding  its  holdings.  And  it  is  not  surprising  to  find 
that  Webster  should  have  been  trustful,  with  the  clean  record  of 
the  states  and  the  splendid  example  set  them  by  the  Federal  Govern- 
ment. But  it  is  surprising  to  find  small  bond  houses  and  their 
salesmen,  in  this  day  of  enlightenment  on  the  moral  delinquencies 
of  states,  urging  the  purchase  of  Southern  and  Western  tax-secured 
bonds  on  the  ground  that  they  yield  a  larger  income  than  the 
Northern  and  Eastern  and  yet  are  equally  well  secured.  Such  a 
statement  can  be  made  only  by  those  who  are  uninformed  or  in- 
sincere. 

412.  The  Present  Attitude  of  the  States.  The  other  "  intangible 
asset "  of  the  state  is  the  security  behind  its  bonds  which  is  in- 
spired by  its  attitude  toward  its  obligations.  The  present  good 
faith  of  almost  every  state  is  beyond  question.  It  is  to  be  ascer- 
tained by  these  principal  means: 

1.  The  provisions  of  its  constitution. 

2.  The  reinforcement  of  its  statutes. 

3.  Recent  decisions  of  its  courts. 

4.  The  amount  and  character  of  its  outstanding  obligations. 

413.  Constitutional  Debt-Restrictions.  In  a  state's  constitution  its 
attitude  toward  the  contraction  or  discharge  of  its  engagements 
may  be  learned  from  several  sections.  The  most  important  relates 
to  debt  limitations. 

In  the  original  constitutions  of  the  older  states  these  limitations 
are  almost  entirely  absent.  They  usually  show  the  working  of 
bitter  experience,  as  in  the  Ohio  constitution  of  1851,  and  are  the 
result  of  amendments  or  of  constitutional  revisions.  The  tendency 
is  toward  greater  strictness — there  being  an  apparent  rivalry  in 
conservatism.  The  constitution  of  Oklahoma,  the  latest  state  to 
be  admitted  into  the  Union,  bears  out  this  statement.  The  very 
wording  of  the  limitations  in  many  constitutions  from  all  parts 

1  Text  as  of  Webster's  Works,  Vol.  XII,  pp.  211-214. 


STATE  BONDS:  THE  ELEMENTS  OF  SECURITY       141 

of  the  country  is  so  uniform  that  a  harmonious  co-working  of  the 
commonwealths  toward  better  conditions  of  state  credit  is  manifest. 
There  are  a  very  few  states,  e.g.  Massachusetts,  New  York,  the 
Garolinas,  Kentucky,  and  Kansas,  which  are  more  or  less  lax  (when 
they  have  any  restrictions  at  all),  as  to  the  creation  of  state  debt; 
but  the  spirit  of  the  time  is  best  illustrated  in  Georgia,  which,  by 
the  constitution  of  1877  has  prohibited  the  creation  of  any  fur- 
ther funded  debt,  and  limits  to  $200,000  the  floating  indebtedness 
which  may  be  outstanding  against  deficient  revenue  at  any  one 
time.  Wisconsin's  constitution  of  1872  will  furnish  a  still  better 
model  of  utmost  rigor  in  its  restrictions. 

414.  In  general  the  constitutions  permit  the  legislatures  to  con- 
tract debt 

1.  to  meet  casual  deficits  in  revenue, 

2.  to  defray  ordinary  expenses  not  otherwise  provided  for, 

3.  to  redeem  existing  funded  indebtedness, 

4.  (sometimes)  to  pay  interest  on  funded  indebtedness, 

5.  to  undertake  public  improvements, 

6.  to  repel  invasion  and  suppress  insurrection. 

The  first  three  are  within  the  immediate  powers  of  the  legisla- 
tures; often  the  last  three  are  valid  only  after  the  referendum. 

415.  But  on  the  other  hand  the  constitutions  generally  forbid 
the  legislatures 

1.  to  incur  floating  indebtedness  beyond  certain  limits, 

2.  to  incur  ordinary  expenses  beyond  certain  limits, 

3.  to  incur  further  funded  indebtedness,  or  at  least  indebtedness 
beyond  a  certain  sum, 

4.  to  incur  indebtedness  for  "  internal  improvements," 

5.  to  assume  the  debts  of  any  municipality,  corporation  or  in- 
dividual, 

6.  to  use  funds  raised  as  above  in  behalf  of  war,  insurrection,  etc., 
or  funds  raised  in  the  interests  of  amortization,  for  any  other  pur- 
pose. 

In  most  states  this  is  the  tenor  of  the  fundamental  law.  And 
it  is  most  reassuring,  especially  in  view  of  the  fact  that  the  entire 
West  and  most  of  the  South  adheres  to  its  general  terms.  To  be 
recommended  for  particular  notice  are  those  sections  of  each  code 
forbidding  the  loan  of  the  state's  credit  for  corporate  enterprise 
or  for  works  of  internal  improvement. 

416.  To  offset  in  slight  degree  this  recent  record  of  antipathy  to 
debt-creation  it  must  be  said  that  Mississippi  and  one  or  two  other 


142       STATE  BONDS:  THE  ELEMENTS  OF  SECURITY 

repudiating  states  interdict  in  their  revised  constitutions  the  pay- 
ment of  the  old  defaulted  bonds. 

417.  Statutory  Debt-Restrictions  and  Corollary  Acts.  So  much  for 
the  constitutions.  As  for  the  statutes,  though  there  is  an  intimate 
and  significanl  relation  between  them  and  the  state's  attitude  to- 
ward its  debt,  the  details  are  too  technical  for  this  place.  To  read 
the  relation  aright  requires  assistance  from  the  bond  attorney. 
An  illustration  will  suffice.  We  have  noticed  previously  that  several 
of  the  commonwealths,  by  the  terms  of  their  revised  constitutions, 
permit  themselves  to  be  sued.  To  what  extent  the  people  or  their 
present  representatives  abet  this  provision,  and  therefore  to  what 
extent  they  are  acting  in  good  faith  respecting  this  particular 
amendment,  may  be  learned  in  each  case  by  consultation  of  the 
statutes  supplementary  to  the  constitution.  When  none  is  to  be 
found  it  is  assumed  by  the  legal  fraternity  that  the  provision  is 
practically  annulled  by  the  will  of  the  people.  Webster,  in  that 
letter  from  which  we  have  already  quoted,  seems  to  be  more  correct 
in  his  diagnosis  of  the  security  of  statutory  law  than  he  was  of  the 
people's  good  faith.  He  said:  "If  it"  (the  state)  "could  not  or 
would  not  make  provision  for  paying  the  bond,  it  is  not  probable 
that  it  could  or  would  make  provision  for  satisfying  the  judg- 
ment." 

418.  Not  only  is  a  state's  attitude  toward  its  debt  to  be  de- 
termined from  statutes  relating  to  the  debt-limitation,  but  also 
from  those  affecting  the  status  of  municipal  obligations.  In  1S70 
the  legislature  of  Tennessee  made  a  crude  attempt  to  enable  its 
municipalities  to  evade  their  debts  by  an  act  disincorporating  cer- 
tain municipalities  and  in  place  forming  new  taxing  districts.  The 
federal  courts  promptly  decided  against  this  childish  effort  to  im- 
pair the  obligation  of  contracts,  and  Tennessee's  credit  still  suffers 
from  it  as  every  bond  man  well  knows. 

419.  But  statutes,  good  or  bad,  can  be  repealed  and  constitutions 
revised;  statutory  law  can  never  rest  for  long  at  greater  moral 
heights  than  the  level  of  average  integrity.  Therefore  the  consensus 
of  sober  opinion  looks  away  from  law  and  toward  history  for  its 
major  judgments.  Thus  it  is  that  New  York,  with  only  slight  con- 
si  itutional  restrictions  upon  the  making  of  its  engagements  and 
with  a  decided  inclination  toward  internal  improvement  by  use 
of  the  state's  name,  and  Massachusetts,  with  absolutely  no  consti- 
tutional restrictions  and  the  largest  debt  in  the  Union,  lead  the 
commonwealths  in  credit. 


STATE  BONDS:  THE  ELEMENTS  OF  SECURITY       143 

420.  Significance  of  Recent  Legal  Decisions.  Common  law,  how- 
ever, is  no  such  handy  instrument  of  a  people's  immediate  will.  It 
does  not  easily  lend  itself  to  purposes  of  municipal  or  state  roguery, 
although  with  adequate  preparation  one  can  at  times  read  by  it  sig- 
nificant indications  of  the  level  of  business  integrity  in  a  com- 
munity. But  as  in  statutory  law  the  investor  will  do  well  not 
to  interpret  without  legal  help.  It  is  not  without  its  significance 
that  the  most  disquieting  recent  decision  by  a  State  Supreme  Court 
comes  from  North  Carolina.  By  virtue  of  this  decision,  at  vari- 
ance, it  seems  to  us,  with  any  sense  of  equity,  a  certain  bond 
house  was  compelled  to  take  an  issue  of  county  obligations,  for  the 
discharge  of  which  it  appeared  there  was  no  possibility  of  levying 
sufficient  taxes.1  The  court  was  divided  in  its  opinion,  and  one 
of  the  dissenting  justices  deprecated  the  decision  as  having  a 
deleterious  effect  upon  credit,  in  these  terms: 

"  I  must  confess,  with  all  possible  deference  to  my  learned  brethren,  that  I 
regard  the  conclusion  at  which  they  have  arrived  as  a  serious  blow  to  the  credit 
of  the  municipal  corporations  ...  of  the  state.  I  fear  that,  relying  upon " 
(a  previous  Supreme  Court  decision)  "many  bonds  have  been  issued  under  acts 
similar  to  the  one  before  us.  Their  value  must  be  seriously  impaired  by  the 
decision  now  made,  which,  I  think,  practically  overrules "  ( the  previous  deci- 
sion) ....  "The  credit  of  the  state  and  its  municipalities  was  never  so 
high  as  at  this  time.  The  uncertainty  of  the  validity  of  our  bonds  is  the  only 
obstruction  to  their  sale  at  higher  figures,  thus  lowering  the  rate  of  interest. 
Next  to  character  and  capacity  the  most  valuable  asset  which  a  people  both 
individually  and  corporately  can  have  is  the  integrity  of  their  obligations.  The 
first  two  elements  of  credit  our  people  possess.  It  is  the  duty  of  the  Legisla- 
ture and  the  courts  to  guarantee  the  last." 

There  is  no  need  to  confirm  the  suspicions  of  the  dissenting  jus- 
tice that  North  Carolina's  attitude  toward  county  obligations,  ex- 
pressed in  such  a  decision  as  this,  militates  against  the  credit  of  the 
state  and  its  corporate  subdivisions. 

421.  Quite  the  opposite  attitude,  in  Montana,  on  the  part  of  the 
legislature,  reassures  the  purchasers  of  her  obligations.  The  an- 
tithesis to  the  preceding  case  is  not  perfect  because  it  was  not  the 
court  but  the  legislature  which  had  the  opportunity  to  prove  a  bul- 
wark to  the  state's  good  faith.  In  1906  the  Supreme  Courts  of 
Montana  and  of  the  United  States  held  invalid  certain  bonds  issued 
by  the  State  Board  of  Land  Commissioners.  Instead  of  hailing  the 
fact  as  an  opportunity  to  escape  just  obligations,  Montana  passed  an 

1  Pitt  County  vs.  MacDonald  et  al.,  61  S.  E.  643    (May,  1908). 


114       STATE  BONDS:  THE  ELEMENTS  OF  SECURITY 

act  in  the  following  year  appropriating  moneys  for  interest  due  till 
1900,  and  providing  for  the  recall  of  the  bonds  from  time  to  time  out 
of  surplus  revenues  in  the  general  fund. 

422.  Significance  of  Amount  and  Character  of  Present  Funded  Obli- 
gations. Reassurance  as  to  the  present  attitude  of  the  common- 
wealths toward  their  debts  is  to  be  had  also  by  a  general  survey  of 
the  several  amounts  and  of  the  purposes  for  which  they  were  issued. 

423.  Five  states  have  no  bonds  at  all,  of  any  sort,  outstanding, 
except  "  overdue  "  bonds.  When  no  debt  is  claimed  for  these  states 
it  means  no  debt  within  their  power  to  pay.  Funded  debt,  past 
due,  represented  by  coupon  bonds,  the  owners  of  which  are  un- 
known, and  registered  bonds,  the  owners  of  which  cannot  be  found, 
is  outstanding  against  almost  every  government.  Of  course  upon 
the  maturity  of  these  bonds  interest  ceased  and  nothing  but  the 
principal  and  accrued  semi-annual  interest  unpaid  at  maturity  re- 
mains a  charge.  Sometimes  bank  deposit  is  made  against  possible 
future  presentation  of  the  bonds.  In  this  class  of  states  are  Ohio, 
Illinois,  Iowa,  South  Dakota,  and  Nebraska. 

424.  Ten  other  states  have  no  "  foreign  debt,"  i.e.  funded  in- 
debtedness in  the  hands  of  the  public;  but  may  have  overdue 
bonds  outstanding,  and  have  "  domestic  debt,"  i.e.  non-negotiable 
certificates  of  indebtedness  held  in  their  own  sinking  funds  and 
other  special  funds,  generally  as  perpetual  loans  with  obligatory 
interest.  This  is  also  often  called  "  irreducible  debt,"  although  the 
word  "  debt "  is  a  misnomer.  It  is  a  technical  and  rather  foolish 
bookkeeping  charge  in  line  with  all  sinking  fund  bookkeeping, 
and  it  generally  balances  its  equivalent  in  assets.1  To  all 
intents  and  purposes  these  states  are  without  debt,  however 
large  the  accounts  may  be.  They  are  New  Jersey,  Michigan,  Wis- 
consin, Minnesota,  Missouri,  Kansas,  Oregon,  Washington,  Nevada, 
and  Kentucky. 

425.  A  third  class  may  be  distinguished,  of  three  states  which 
have  no  legal  debt  except  as  above,  but  which  have  obligations  to 
the  public  they  will  not  recognize.  They  are  Arkansas,  Florida, 
and  West  Virginia. 

426.  With  eighteen  of  the  forty-six  states  of  the  Union  practi- 
cally free  from  bonded  debt,  and  several  others,  e.g.  Missouri,  with 
only  a  small  sum  publicly  held,  we  may  well  be  congratulated  on 
the  change  in  financial  policy  that  has  taken  place  during  the  past 

1  Certificates  of  indebtedness  are  sometimes  classed  as  bonds  in  statutes,  and 
sometimes  not. 


STATE  BONDS:  THE  ELEMENTS  OF  SECURITY       145 

twenty  years.  The  great  majority  of  these  states  with  substantial 
indebtedness  to  the  public,  we  shall  presently  take  occasion  to  say, 
have  quick  assets  in  the  form  of  treasury  money  and  the  like,  which 
make  their  net  indebtedness  trivial. 


Security  :  Tangible  Assets 

427.  It  has  been  made  sufficiently  clear  that  the  security  behind 
the  bonds  of  a  state  rests  mainly  on  its  credit,  and  since  the  state 
is  a  quasi-sovereign,  that  this  credit  is  represented  mainly  by  the 
state's  will  toward  the  debts  of  its  own  creating,  and  that  this 
will  is  to  be  judged  in  the  light  of  the  history  of  the  state  debt 
and  of  the  state's  present  attitude,  however  determined,  toward  its 
debt. 

These  factors  which  make  for  state  credit  are  intangible  factors, 
or  to  revert  to  the  metaphor  of  the  preceding  paragraphs, — in  the 
inventory  of  a  state's  wealth  they  are  not  measured  in  dollars  and 
cents:  they  are  intangible  assets. 

428.  The  Tax  Power.  And  yet  though  not  measurable,  and  ex- 
ceedingly subtle,  the  intangible  assets  of  the  state,  on  evaluation, 
are  found  very  sensitive  to  the  condition  of  the  tangible  assets,  or 
material  wealth.  In  tracing  the  history  of  state  debts  we  noticed 
that  the  two  chief  outbreaks  of  default  and  repudiation  closely 
attended  two  periods  of  severe  business  depression.  The  direct 
connection  between  the  two  kinds  of  assets  is  the  tax  power.  There 
has  been  no  case  of  default  on  state  bonds,  whether  valid  or  invalid, 
when  the  resources  of  the  state  were  sufficient  to  pay  without  hard- 
ship the  annual  state  levy. 

429.  To  him  who  seeks  the  material  sources  of  a  state's  credit, 
the  tax  power  is  an  immediate  consideration.  He  should  learn  in 
the  first  place  whether  the  state  now  levies  a  general  tax.  If  it 
does  without  any  tax,  well  and  good;  in  an  emergency  this  might 
prove  a  fresh  resource.  Vermont,  Pennsylvania,  Delaware,  and 
Wisconsin  have  this  distinction, — all  four  states  with  small  or  no 
funded  liabilities.  In  lieu  of  a  general  tax,  revenue  is  dependent 
upon  interest  from  treasury  assets,  and  from  license  taxes  and 
special  taxes  on  corporate  capital  stock,  stock  transfer,  corporate 
loans,  collateral  inheritances,  charters,  etc.,  etc.  New  York  State, 
also,  has  no  direct  tax. 

430.  Secondly,  he  should  note  the  tax  rate  and  the  comparative 
degree  of  burden  it  imposes.     In  comparing  the  tax  burdens  of 


146      STATE  BONDS:  THE  ELEMENTS  OF  SECURITY 

two  states  he  should  sec  thai  he  has  in  hand  the  real,  rather  than 
the  nominal  tax  of  both  as  a  basis.  Sometimes,  as  in  Massachu- 
setts, the  nominal  state  tax  is  the  average  of  the  municipal  tax 
rates,  and  the  tax  for  the  immense  contingent  debt  is  annually 
levied  directly  upon  the  cities  and  towns  benefited  by  it.  Some- 
times the  tax  is  somewhat  split  up,  and  therefore  deceptive.  In- 
diana has  the  usual  General  Fund  tax,  but  special  taxes  for  be- 
nevolent institutions,  public  schools,  sinking  funds,  and  educational 
institutions.  Vermont  has  no  general  state  tax,  but  in  the  capacity 
of  agent  relieves  the  districts  of  direct  taxation  by  raising  special 
levies  for  such  district  purposes  as  school  and  highway-building 
and  redistributes  the  proceeds  to  the  towns,  etc.,  by  process  of 
equalization.  Connecticut  in  like  manner  remits  the  proceeds  of 
its  corporation  taxes. 

431.  Thirdly,  the  investigator  should  particularly  note  that  in 
one  or  two  instances  the  commonwealths  have  imposed  a  constitu- 
tional limit  to  the  rate  of  the  state  tax  levy.1  Georgia  limits  the 
tax  to  $5.00  a  thousand;  Alabama  to  $0.50  a  thousand.  This  is 
not  only  placing  the  restriction  where  it  does  not  belong,  but,  if 
the  custom  should  spread,  might  come  to  have  an  important  bearing 
on  validity.  If  the  tax  limit  in  a  given  case  had  been  nearly 
reached,  such  a  provision  might  make  impossible  the  levy  of  a 
remedial  tax  in  time  of  emergency,  such  as  arose  in  Nebraska  in 
1877.  That  year  a  pest  of  grasshoppers  destroyed  vegetation,  and 
by  means  of  a  special  levy  the  state  was  enabled  to  borrow  funds 
to  distribute  seed  grain  to  the  farmers. 

432.  Lastly  and  most  important,  some  well-grounded  opinion 
should  be  arrived  at  on  the  following  questions :  What  is  the  ratio 
of  the  present  to  the  possible  or  practicable  state  tax?  What  is 
the  ratio  of  the  present  state  tax  to  the  possible  aggregate  of 
municipal  taxes?  What  is  the  ratio  of  the  present  state  tax  to 
the  present  aggregate  of  municipal  taxes?  A  commonwealth  may 
be  without  real  public  bonded  debt  and  yet  be  less  prepared  to 
support  one  because  of  high  internal  tax  rates,  than  another  com- 
monwealth with  many  and  large  funded  obligations,  which  has, 
however,  a   light  load  of  internal  debts. 

433.  Taxable  Wealth  and  Assessed  Valuation.  With  the  excep- 
tion of  states  having  a  constitutional  tax-limitation,  and  even  pos- 
sibly then, — ultimately,  the  resources  of  the  tax  power  depend  on 
the  ratio  of  the  actual  total  state  tax  to  the  taxable  wealth.    This 

2  Not  to  be  confused  with  the  more  common  municipal  tax  limitation. 


STATE  BONDS:  THE  ELEMENTS  OF  SECURITY       147 

ratio  is  not  always  the  same  thing  as  the  tax  rate;  it  depends  on 
whether  the  taxable  wealth  and  assessed  valuation  of  a  certain  state 
are  synonymous  terms.  In  other  words  it  depends  on  whether,  as  in 
Massachusetts,  the  state  assesses  all  property  within  its  borders 
at  full  valuation.  Since  the  taxable  wealth  of  the  state  is  known 
to  the  public  at  large  only  in  terms  of  assessed  valuation,  and 
since  assessed  valuation  is  arrived  at  in  various  ways  by  the  dif- 
ferent states,  and  by  various  ways  within  a  single  state,  we  are 
confronted  not  by  an  insular  but  a  comparative  study,  with  statis- 
tical materials  requiring  careful  analysis.  The  analysis,  however,  is 
well  worth  while,  for  assessed  valuation  represents  the  chief  of  the 
tangible  assets. 

434.  Equalized  Valuation.  It  is  disconcerting  to  find  the  num- 
ber and  variety  of  means  by  which  the  figures  for  assessed  valuation 
are  attained.  If  it  is  the  year  of  a  state  census,  the  results  are 
more  likely  to  be  dependable,  especially  in  the  West,  because  ob- 
tained under  state  supervision  and  by  more  uniform  methods. 
If  not  such  a  year  the  aggregate  may  be  compiled  wholly  from  in- 
ventories of  cities  and  towns,  or  else  from  county  totals,  which  in 
turn,  to  save  time  and  labor,  have  been  constructed  by  changing  to 
scale  the  figures  of  the  preceding  assessment.  But  since  in  those 
states  which  do  not  uniformly  require  assessment  at  full  value  the 
differences  in  tax  rate  require  adjustment  by  a  board  of  equaliza- 
tion, the  whole  subject  has  its  full  share  of  perplexities. 

435.  In  not  a  few  of  the  states  there  is  a  general  assessment 
of  real  estate  only  once  in  a  period  of  several  years  (Michigan 
every  five  years,  Illinois  every  four  years),  although  personal  prop- 
erty may  be  listed  every  year.  In  the  intervening  annual  returns, 
therefore,  the  valuation  of  real  estate  (the  larger  part  of  the  whole) 
is  arbitrary,  and  detracts,  like  the  process  of  equalization,  from  the 
accuracy  of  estimates  and  from  the  value  of  comparisons.  Even 
in  states  that  are  presumed  to  revalue  property  annually,  there  is 
a  general  suspicion  among  officials  that  a  thorough-going  reassess- 
ment is  occasional  rather  than  periodic. 

436.  Relation  of  Assessed  Valuation  to  Real  Valuation.  To  be  wel- 
comed therefore  as  a  tendency  toward  betterment  in  statistical 
methods  is  the  recent  movement  to  make  assessed  valuation,  or  at 
least  appraised  valuation,  when  the  two  differ  as  in  Illinois,  the 
same  as  real  valuation.  Massachusetts,  Connecticut,  and  Illinois 
took  this  step  years  ago;  West  Virginia  in  1905,  and  New  Jersey 
in  1906.     Any  tendency  toward  uniformity  is  to  be  welcomed  as 


148      STATE  BONDS:  THE  ELEMENTS  OF  SECURITY 

removing  obstacles  to  comparative  studies.  And  yet  in  this  case 
the  reform  brings  its  own  troubles.  On  comparing  successive  val- 
uations in  a  state  over  a  period  of  years  to  determine  the  rate 
of  its  growth  or  retrogression,  the  change  in  basis  of  appraise- 
ment is  likely  to  be  overlooked.  In  Connecticut  for  instance: — on 
the  face  of  things  Connecticut  shows  a  remarkable  growth  in  wealth 
during  the  past  twenty  years,  for  such  a  settled  state,  having  al- 
most doubled  its  assessed  valuation.  But  the  cold  reality  is  that 
Connecticut's  basis  of  appraisement  twenty  years  ago  was  not  much 
over  50  per  cent;  yet  to-day,  as  stated,  it  is  at  actual  value.1 

437.  Comparison  of  Valuations.  With  these  precautions  in  mind 
much  light  on  a  state's  financial  condition  may  be  gained  by  com- 
parison of  its  present  with  its  past  valuations,  and  of  its  present 
with  the  present  valuations  of  other  states.  Surely  no  one  has  any 
but  himself  to  blame,  who  in  1870  or  thereafter  bought  the  loans 
of  Louisiana,  which  were  subsequently  repudiated,  when  he  had 
before  him  the  fact  that  the  debt  had  doubled  in  the  preceding 
decade  and  the  assessed  valuation  of  all  property  had  declined 
one-third.  And  the  same  course  of  reasoning  would  have  applied 
to  the  loans  of  any  other  repudiating  state. 

438.  The  Components  of  Assessed  Valuation.  Assuming  now  that 
the  investigator  appreciates  the  statistical  difficulties  of  the  ap- 
praisal and  comparison  of  assets,  he  should  analyze  the  assets 
themselves,  for  they  vary  greatly  in  degree  of  resource  should  need 
arise  of  sudden  increase  in  state  loans. 

The  large  division  of  assessed  valuation  into  real  and  personal 
property  goes  without  saying.  Many  states  separately  itemize  in 
their  general  reports  the  tax  resources  contained  in  bank  and  trust 
company  stocks  and  deposits,  in  the  capitalization  of  railroad, 
telegraph,  telephone,  and  insurance  companies,  and  generally  in 
the  chartering  and  capitalization  of  corporations.  These  resources 
are  entirely  at  the  command  of  the  legislatures  in  the  same  sense 
that  real  property  is.  Here  again  we  find  no  uniformity  of  use  in 
regard  to  the  tax  power.  In  some  states  objects  are  taxed  that  in 
others  are  not ;  and  the  rates  on  the  same  objects  vary.  Massachu- 
setts taxes  savings  bank  deposits  one-half  of  one  per  cent.  Ver- 
mont taxes  savings  bank  and  trust  company  deposits  seven-tenths  of 
one  per  cent.  Vermont  taxes  the  gross  earnings  of  her  railroads 
two  and  one-half  per  cent.     Other  slates  tax  in  preference  rail- 

1  In  Connecticut  a  minor  change  affecting  the  returns  of  valuation  has  been 
an  alteration  in  the  method  of  posting  the  grand  lists. 


STATE  BONDS:  THE  ELEMENTS  OF  SECURITY       149 

road  capitalization.  Missouri  taxes  machinery,  tools,  and  mer- 
chandise in  one  appraisal  and  the  public  utilities  in  another;  but 
neither  tax  duplicate  is  carried  over  to  the  statement  of  general 
assessed  valuation.  These  variations  in  bookkeeping  all  effect 
results  and  should  be  reckoned  with. 

439.  Other  Items  of  Material  Wealth.  There  is  other  material 
wealth  which,  being  the  property  of  the  state,  as  such, — proprie- 
tary assets, — is  not  usually  a  resource  of  the  tax  power,  but 
may  prove  on  examination  to  be  of  first  importance  as  imme- 
diately balancing  state  liabilities.  Some  states  have  revenue-pro- 
ducing realty;  South  Carolina  has  beds  of  phosphate  deposit  which 
formerly  were  of  great  help  in  meeting  the  annual  budget.  Treas- 
ury assets  pure  and  simple  are  very  generally  neglected  in  com- 
parisons of  state  resources.  Wyoming  has  unattached  cash  and 
securities  on  hand  equal  to  five  times  her  bonded  debt;  Delaware 
for  years  has  had  free  assets  greatly  in  excess  of  her  liabilities, 
Nevada,  free  assets  equal  to  125  per  cent,  of  her  (nominal)  bonded 
debt.  Oklahoma  has  no  bonded  debt,  but  the  cash  in  all  funds  is 
about  two-thirds  the  amount  of  her  warrants  outstanding.  New 
York,  with  a  bonded  debt  of  $57,000,000,  has  a  sinking  fund  of 
$24,000,000.  Even  Massachusetts,  with  its  enormous  debt  (di- 
rect and  contingent)  of  well  over  $100,000,000,  has  sinking  funds 
equal  to  one-quarter  of  the  amount.  New  Jersey,  with  no  debt 
publicly  held,  has  cash  in  her  state  fund  of  over  four  and  one-half 
millions,  and  railroad  stock  of  considerable  value.  Some  states 
in  the  West  and  South  have  sequestrated  special  funds  for  char- 
itable and  educational  purposes  largely  in  excess,  both  as  to  prin- 
cipal and  interest,  of  the  nominal  state  debt.  It  is  because  of  this 
fact  that  we  are  justified  in  calling  free  from  debt  those  states 
mentioned  in  Class  II  above.  All  Nevada's  bonds  are  so  held  and 
in  addition  a  part  of  her  fiduciaries  are  invested  in  about  one  mil- 
lion and  a  quarter  of  Massachusetts  state  bonds  and  United  States 
Governments.  The  situation  is  somewhat  analogous  in  California's 
"  Sea  Wall "  and  "  Depot "  loans.  These  are  to  be  paid  from  the 
collections  of  the  San  Francisco  Harbor  Commission. 

440.  Of  course  the  value  of  all  revenue-producing  loans  and  the 
justification  for  discarding  them  in  arriving  at  a  state's  real  net 
debt,  depends  upon  the  character  of  the  enterprise  they  assist  and 
the  assured  permanency  of  its  income.  The  old  canal,  railroad  aid, 
and  bank  bonds,  of  ill  repute,  were  at  one  time  technically  in  this 
revenue-producing  class.     Perhaps   the  line  of   cleavage  between 


150       STATE  BONDS:  THE  ELEMENTS  OF  SECURITY 

issues  which  may  and  which  may  not  be  discarded  lies  in  the  pur- 
pose of  issue.  Revenue-producing  corporate  aid  bonds,  should,  from 
the  lessons  of  the  past,  not  be  booked  by  the  bond-buyer  as  any- 
thing but  a  pure  liability,  and  revenue-producing  loans  issued  for 
purposes  of  public  improvement,  like  the  California  "  Sea  Wall " 
bonds,  should  be  omitted  as  at  least  self-subsisting. 

441.  Population.  An  indirect  asset,  if  it  may  so  be  called,  that 
should  not  be  neglected,  is  population.  The  poll  tax  of  itself  is  no  in- 
considerable resource.  As  an  index  of  growth  or  decline  in  material 
wealth  statistics  of  population  are  serviceable.  In  Nevada,  for 
instance,  the  decline  in  population  suggests  the  subsidence  of  silver 
mining,  its  chief  industry,  and  in  Washington  the  growth  of  popu- 
lation— the  most  remarkable  in  the  Union  during  the  past  decade — 
is  in  keeping  with  the  marvelous  development  of  this  state  during 
the  period.  Needless  to  say  municipalities  there  sell  their  bonds 
with  a  lower  interest  rate  and  at  a  higher  figure  than  ten  years  ago. 

442.  In  comparisons  of  population,  temporal  and  geographical, 
certain  extraneous  and  occasional  influences  should  be  taken  into 
account,  viz.,  the  enfranchisement  of  the  negro  after  the  War,  and 
from  the  census  of  1900  on,  the  inclusion  of  the  Indian  population 
on  the  Reservations. 

443.  Obviously  the  character  of  the  population  is  of  first  im- 
portance, and  closely  second  to  it  the  character  of  present  or  ex- 
pected accretions  from  birth  and  immigration.  Those  Northwest- 
ern states  which  are  being  settled  by  the  sober,  virile  races  of  North- 
ern Europe  will  in  all  probability  make  impossible  a  repetition  of 
Minnesota's  repudiation.  In  the  South  it  is  a  question  to  what 
extent  the  growth  in  population  of  the  blacks  is  a  menace  to  credit. 
Their  rate  of  increase  per  cent,  is  not  so  great  in  a  majority  of  the 
Southern  states  as  the  rate  of  increase  among  the  white  population. 

444.  Bank  Statements.  Another  index  of  growth  in  prosperity 
is  the  bank  statement.  It  is  not  unusual  to  see  on  a  bond  circular 
a  comparative  statement  of  bank  clearings.  Apropos  again  of  the 
South,  and  its  rapidly  improving  conditions,  in  1880  the  resources 
of  the  Southern  National  banks  were  $171,464,000.  In  1900  they 
had  grown  to  $516,798,000,  and  in  1909  to  $1,177,000,000,  or  over 
100  per  cent.  In  1900  the  deposits  in  state,  savings,  and  private 
banks  and  trust  companies  were  $254,439,000;  in  1910  they  were 
$624,752,000.  The  commercial  agencies  say  that  statements  of 
bank  clearings  in  the  newer  communities  are  sometimes  unreliable 
and  must  therefore  be  viewed  with  caution. 


STATE  BONDS:  THE  ELEMENTS  OF  SECURITY       151 

445.  Offsets  of  Liabilities.  Just  as  there  is  reason  to  offset  against 
gross  bonded  indebtedness  such  quickly  convertible  treasury  assets 
and  stable  income-producing  properties  as  a  state  may  have,  so 
again,  it  should  be  understood  that  these  assets  have  their  like 
offsets, — that  state  bonded  indebtedness  is  by  no  means  the  only 
or  chief  liability  of  the  people  of  the  state,  and  therefore  of  the 
state,  since  the  courts  recognize  as  the  ultimate  obligor,  not  po- 
litical or  corporate  bodies,  but  the  very  people  themselves.  The 
chief  encroachment  on  state  tax  resources  is  the  existence  of  mu- 
nicipal indebtedness.  This  fact  is  not  usually  given  due  weight. 
It  ought  seriously  to  militate  against  the  price  of  Kansas  loans 
should  any  ever  be  offered  the  public.  Put  in  other  words,  the 
security  behind  state  bonds  is  partly  dependent  on  limitations  as 
to  municipal  indebtedness.  Only  the  surplus  revenues  of  business 
activity  are  taxable,  and  the  interest  on  and  redemption  of  munici- 
pal loans  eat  into  this  directly.  It  is  a  well-established  principle 
of  law,  relating  to  civil  governments  and  corporations  as  well  as 
to  individuals,  that  a  debtor's  right  to  life  and  liberty  is  prior  to 
a  creditor's  claim.  No  court  would  prejudice  the  solvency  of  a 
state  (when  sued)  or  of  its  civil  divisions,  in  the  interest  of  any 
bondholder.  And  so  it  is  for  the  bond  purchaser  to  see  that  the 
tax  burden  of  the  lesser  civil  divisions  is  not  perilous  to  the 
interests  of  the  state  debt.  The  principles  here  outlined  apply  in 
the  same  way  with  equal  force  to  a  state's  contingent  debt.  It  is  to 
be  doubted  whether  any  state  has  repudiated  its  bonds  without,  as 
part  or  main  cause,  the  failure  of  revenues  for  bonds  of  its  guaran- 
teeing,— in  other  words,  for  its  contingent  debt.  Massachusetts 
offers  at  present  the  best  field  for  study  of  this  class  of  liability. 

446.  Warrants  and  other  floating  indebtedness  should  also  be 
considered.  The  list  of  states  without  bonded  debt,  given  pre- 
viously, would  have  been  misleading  were  bonded  and  floating  debt 
virtually  the  same.  Both  Iowa  and  Nebraska,  for  example,  have 
large  interest-bearing  debts  but  no  bonds,  and  Oklahoma's  small 
debt  is  all  in  warrants.  There  is  a  moral  distinction  of  importance 
between  the  two  kinds  of  obligations.  A  floating  debt  may  be  car- 
ried along  from  year  to  year,  indefinitely,  but  the  very  fact  that  it 
has  not  been  funded  indicates  (in  lack  of  constitutional  provisions) 
an  unwillingness  to  create  debt  of  long  standing  and  an  intention 
to  retire  it  when  revenues  permit.  However,  as  a  pure  liability, 
floating  debt  should  be  looked  to  as  seriously  as  any  other.  Colo- 
rado at  one  time  had  such  a  debt  in  excess  of  constitutional  limits. 


152      STATE  BONDS:  THE  ELEMENTS  OF  SECURITY 

Security  as  Vested  in  the  Bond  Issue 

447.  We  have  considered  up  to  this  point  the  security  for  state 
bonds  vested  in  a  state's  intangible  and  tangible  assets, — that  is, 
in  its  "sentimental"  credit  and  in  its  tax  resource  as  they  are 
dependent  on  each  other.  There  is  a  word  to  be  said  in  closing  as 
to  the  security  vested  in  the  issue  itself. 

448.  Amortization:  Sinking  Fund  and  Serial  Repayment.  First  as 
to  sinking  funds.  This  subject  in  its  large  aspects  has  been  thor- 
oughly covered  already.  It  is  necessary  here  only  to  repeat  that 
the  sinking  fund  principle,  whether  applied  to  government,  state, 
municipal,  or  corporation  issues,  is  wasteful,  and  renders  a  fund 
liable  to  depletion  by  misappropriation,  embezzlement,  and  other 
fraud,  and  to  depreciation  in  its  investments.  Of  what  use  to 
Virginia  was  that  part  of  her  sinking  funds  which  held  the  Kiddle- 
berger  bonds,  when  the  state  paid  interest  on  those  in  the  hands  of 
the  public,  but,  for  years,  not  on  those  in  the  sinking  funds? 
Mississippi  illustrates  best  the  vicissitudes  of  this  method  of  amor- 
tization. In  1830  a  sinking  fund  of  $250,000  was  started  for  the 
Planters'  Bank  bonds  from  the  premium  secured  at  their  sale.1 
By  1839,  when  the  bank  failed,  this  sum  had  increased  to  about 
$800,000,  but  within  one  year,  by  mismanagement  and  depreciation 
in  its  investments,  had  dwindled  to  $525,705,  and  by  1848  to  about 
$100,000!  By  the  constitution  of  Pennsylvania  her  sinking  funds 
may  be  diverted,  at  the  will  of  the  legislature,  from  the  extinguish- 
ment of  the  public  debt,  for  use  in  war,  invasion,  or  insurrection. 

449.  A  railroad  president  has  said :  "  The  best  way  to  sink  a 
debt  is  to  pay  it;  the  surest  sinking  fund  is  payment."  2  A  few  of 
the  younger  states  have  set  a  much  needed  example  to  the  older 
by  adopting  the  serial  method  of  payment,  or  at  least  by  making 
redemption  possible  before  regular  maturity.  All  Idaho  bonds  with 
one  exception  are  subject  to  call  ten  years  before  regular  maturity, 
and  because  that  one  exception  is  not  now  redeemable  the  state  is 
obliged  to  pay  one  per  cent,  more  interest  on  the  face  of  the  loan 
than  on  any  of  the  others.  By  the  constitution  of  Wisconsin  a  law 
creating  a  debt  "  shall  provide  for  levying  an  annual  tax  sufficient 
to  pay  the  annual  interest  of  such  debt  and  the  principal  within 
five  years  from  the  passage  of  such  law  .  .  .  and  such  appropria- 

1 "  Banking  and  Repudiation    in   Mississippi,"  Bankers'   Magazine,    1863. 
3  The  Sinking  Fund,  G.  M.  Browne,  2d  ed.,  p.  10. 


STATE  BONDS:  THE  ELEMENTS  OF  SEGURITY       153 

tion  shall  not  be  repealed,  nor  the  taxes  posponed  until  the  princi- 
pal and  interest  .  .  .  shall  have  been  wholly  paid."  The  wording 
of  Minnesota's  constitution  is  practically  the  same,  except  that  ten 
years,  not  five,  is  the  period  set. 

450.  Maine,  however,  has  adopted  the  best  plan  of  all:  straight 
serial  repayment.  When  Maine  refunded  her  old  debt  in  1889  she 
caused  her  new  loans  to  mature  in  annual  instalments.  West  Vir- 
ginia, by  the  constitution  of  1872,  requires  the  serial  method  of  re- 
tiring any  loan  she  may  put  forth.  Massachusetts,  with  the  most  need 
of  all,  because  of  the  immensity  of  her  debt,  has  done  less  than  she 
might  to  improve  her  condition  by  sound  fiscal  methods,  and,  in  re- 
spect to  the  contingent  debt,  which  is  the  larger  part  of  her  obliga- 
tions, has  until  very  recently,1  even  withheld  from  the  forty  and  more 
cities  and  towns  which  must  pay  it,  the  privilege  of  discharging  it 
by  the  serial  method.  It  is  a  pleasure  to  record  that  through 
the  public  spirit  of  a  gentleman  who  has  saved  his  own  town  of 
Brookline  nearly  a  million  dollars  in  interest  during  the  past 
twenty  years  by  agitation  and  exposition  of  the  serial  method,  and 
incidentally,  has  kindly  assisted  in  the  preparation  of  this  book, 
the  cities  and  towns  in  the  Metropolitan  District  of  Massachusetts 
are  privileged  to  avail  themselves  hereafter  of  the  serial  method  of 
financing  the  obligations  of  the  Metropolitan  District.  Had  the 
three  principal  loans  of  the  District  (running  forty  years)  been 
issued  in  serial  form,  even  at  one-half  per  cent,  higher  rate  than 
under  the  sinking  fund  form,  the  saving  in  interest  account  would 
have  been  $26,000,000,  and  the  saving  in  actual  cost  to  taxpayers 
about  $8,360,000  on  a  3^  per  cent,  basis.2 

451.  Validity.  But  if  there  is  any  one  thing  an  issue  ought  to 
bear  on  its  face,  metaphorically,  and  literally  as  far  as  possible 
in  the  recital  of  the  bond,  it  is  validity.  It  has  been  said  previously 
that  no  state  has  repudiated  its  bonds,  whether  valid  or  invalid, 
when  the  tax-burden  was  not  a  hardship;  but  conversely,  seldom 
(Mississippi  in  1852  and  one  or  two  other  instances  excepted)  has 
a  state  with  an  unbearable  tax-burden  repudiated  its  obligations 
without  some  show  of  invalidity.  More  than  one  volume  would  be 
needed  to  develop  adequately  this  topic  of  validity.  Bond  law, 
however,  has  progressed  to  such  a  stage  that  opportunities  for 
doubt   seldom    arise    in   connection    with    state   issues.      But   the 

1  Changed  by  the  Acts  of  1905,  chapter  169. 

2  Cf.  The  Metropolitan  Debts  of  Boston  and  Vicinity,  Alfred  D.  Chandler, 
Brookline. 


154       STATE  BONDS:  THE  ELEMENTS  OF  SECURITY 

method  of  authorization  and  notation,  and  the  purpose  of  issue 
have  been  fruitful  sources  of  trouble  in  the  past.  Kansas  at  one 
time  authorized  a  loan  in  aid  of  an  oil  refinery.  If  memory  serves, 
the  issue  was  declared  illegal  before  being  sold  and  no  harm  was 
done. 

452.  An  anecdote  will  illustrate  the  attitude  of  caution  respect- 
ing purpose  of  issue  assumed  by  the  well  informed,  as  the  result 
of  past  defaults.  A  lawyer  friend  and  client  of  the  writer,  but 
not  a  bond  attorney,  offered  to  buy  some  State  of  Massachusetts 
3|s  issued  for  the  purpose  of  building  a  court  house.  Upon  finding 
these  all  sold  he  was  with  difficulty  persuaded  to  take  State  of 
Massachusetts  3|s  of  the  same  date  of  issue  and  maturity,  at  the 
same  price,  and  authorized  by  the  same  law, — in  fact  in  every  re- 
spect absolutely  the  same  as  the  Court  House  bonds  except  that 
they  were  issued  for  the  purpose  of  highway  improvement.  The 
incident  carried  with  it  a  lesson  as  well  as  some  amusement,  and 
was  the  immediate  cause  of  the  care  and  fullness  of  detail  which 
have  been  given  these  chapters. 

453.  Texas  has  the  distinction  of  guaranteeing  the  legality  of 
her  county  and  municipal  issues.  All  loans  of  date  subsequent  to 
1893  must  bear  the  certificate  of  the  Attorney  General  that  they 
are  lawful  obligations;  and  when  so  certificated  they  may  not  be 
challenged  for  validity.  It  is  our  recollection  that  one  or  two  states 
do  likewise  for  their  own  state  loans.  It  is  at  any  rate  a  plan 
worthy  of  advertisement  and  imitation,  and  therefore  mentioned 
in  this  place. 

454.  Although  there  is  little  danger  in  purchasing,  through  well- 
equipped  bond  houses  of  repute,  recent  issues  of  state  bonds,  there 
are  so  many  plausible-looking  certificates  afloat,  souvenirs  of  the 
Reconstruction  Period,  that  one  should  carefully  scrutinize  old 
paper  coming  into  his  possession.  In  1884  the  face  value  of  all 
bonds,  state  and  territorial,  upon  which  interest  was  being  paid, 
aggregated  $190,000,000;  upon  which  interest  was  being  defaulted, 
something  over  $200,000,000.  As  a  majority  of  all  state  bonds 
afloat  at  that  lime  were  in  default,  and  since  a  majority  of  the  old 
defaulted  bonds  are  unrecognized  and  undoubtedly  forever  void, — 
repudiated  by  constitutional  enactment,  or  having  expired  by  limi- 
tation of  the  refunding  compromise  period,  very  few  of  these  old 
loans  are  worth  owning  at  any  price. 

455.  There  are  a  few  other  certificates  that  it  is  possible  to  buy 
under  misapprehension.     These  may   be  called  quasi-state  bonds. 


STATE  BONDS:  THE  ELEMENTS  OF  SECURITY      155 

There  is  a  recent  Minnesota  State  University  two  year  loan,  for  in- 
stance, issued  by  the  Regents  of  the  State  University,  "  the  pay- 
ment of  which  is  pledged  by  a  direct  tax  on  all  the  taxable  property 
of  the  state,"  under  authority  of  an  act  of  legislature.  It  would 
be  hard  to  catalogue  these  bonds.  Since  their  security  is  the  tax 
power  they  are  not  corporation  bonds,  and  yet,  since  the  corpora- 
tion of  the  Regents  promises  to  pay,  and  they  are  not  issued  by 
the  state,  nor  secured  by  pledge  of  "  the  faith  and  credit  of 
the  state,"  the  state  is  not  the  direct  or  primary  obligor,  but 
technically  appears  in  the  position  of  guarantor,  and  pledges  a 
specific  tax.  The  bonds  therefore  are  not  state  bonds.  Montana 
has  similar  educational  loans,  for  the  payment  of  interest  and 
principal  of  which  the  state  is  not  liable,  and  yet  for  the  payment 
of  which  it  pledges  the  proceeds  of  the  sales,  rentals,  and  privileges 
of  certain  public  lands.  These  bonds  are  only  a  little  if  any  less 
secure  than  the  direct  state  loans,  and  the  permanent  University 
Bond  Fund,  created  to  amortize  the  debt,  has  risen  to  proportions 
almost  commensurate  with  the  debt  itself. 

456.  Investment  Value:  Price  and  Income  Yield.  With  all  that 
has  gone  before  it  is  hard  to  reach  any  other  conclusion  than  that, 
as  a  class,  state  bonds  are  not  so  desirable  for  investment  as  the 
better  grade  obligations  of  municipalities,  for  a  considerably  higher 
price  must  always  be  paid  to  secure  state  bonds  of  equal  investment 
worth.1  At  a  time 2  when  50-year  bonds  of  New  York  City  were 
to  be  had  on  a  3.90  per  cent,  basis  of  return,  and  short  term  bonds 
of  Baltimore  on  a  3.95  basis,  it  is  difficult  to  see  the  advantage  of 
buying  50-year  bonds  of  New  York  State  and  short  term  Maryland 
bonds  on  a  3  and  3.10  basis  respectively.  But  more  in  particular, 
why  should  one  buy  Georgia  bonds  on  a  3.50  per  cent.,  Alabama 
bonds  on  a  3.75  per  cent.,  and  Tennessee  bonds  on  a  4  per  cent, 
basis,  to  say  nothing  of  Virginia  and  the  Carolinas,  at  a  time  when 
there  are  very  few  cities  in  the  country  with  credit  so  strong,  and 
inducements  like  exemption  from  tax  and  long  duration  of  loan 
so  enticing,  as  to  float  a  loan  upon  a  3.50  per  cent,  basis? 

457.  Market  Factors.  We  have  cited  Tennessee.  Tennessee  Set- 
tlement 3s,  suggesting  repudiation  and  compromise  in  the  very 
title,  were  given  in  1883,  at  the  rate  of  50  cents  on  the  dollar, 
for  6s  which  had  been  repudiated.    And  such  old  6s  as  were  not  re- 

1  The  principle  called  "  distribution  of  risk "  favors  state,  as  compared  with 
municipal,  bonds. 
a  September,  1908. 


156      STATE  BONDS:  THE  ELEMENTS  OF  SECURITY 

funded  before  January  1,  1907,  were  by  that  fact  made  void.  Yet 
these  Settlement  3s  of  1913  sell  at  present  on  a  4  per  cent,  basis. 
In  1879  the  old  6s  sold  ai  33!  Not  all,  but  some  part  of  that  differ- 
ence, is  caused  by  the  artificial  demand  for  slate  bonds  of  which 
we  spoke  earlier  in  the  chapter.  A  large  part  of  the  demand  comes 
from  insurance  companies.  The  Insurance  Commissioner  of  Ten- 
nessee writes  that  the  law  requires  insurance  companies  doing  busi- 
ness in  that  state  to  deposit  United  States  bonds,  bonds  of  Tennes- 
see or  some  other  state  in  the  Union,  or  real  estate  mortgages.  It 
is  well  known  that  quite  an  amount  of  Tennessee  state  bonds  is  so 
held  by  insurance  companies  for  business  in  that  state. 

458.  On  the  face  of  it  this  compulsory  demand  seems  to  arise 
naturally  enough.  The  vogue  of  similar  insurance  laws  is  quite 
general  throughout  the  country,  in  Cuba,  and  elsewhere.  But  the 
origin  and  perhaps  the  prevalence  of  the  laws  is  due  to  a  deliberate 
effort  to  create  this  compulsory  and  artificial  demand.  At  least 
that  wras  the  contemporary  explanation  in  1869  when  the  South 
Carolina  legislature,  "  in  order  to  create  a  more  active  demand  for. 
the  state  bonds,  passed  a  law  binding  all  insurance  companies  doing 
business  in  the  state  to  deposit  state  bonds  to  the  amount  of  $50,000 
in  the  hands  of  the  Treasurer  as  a  guarantee  of  solvency."  x  If  this 
was  the  purpose  it  proved  successful,  and  the  state  6s,  which  before 
and  after  sold  in  the  twenties  and  thirties,  rose  for  a  time  as  high 
as  87. 

459.  In  like  manner  many  sorts  of  trust  funds,  both  public  and 
private,  by  choice  or  imitation,  create  a  demand  for  state  bonds. 
Congress  in  behalf  of  the  National  Government,  invests  important 
trust  funds  in  certificates  of  state  stocks.  Nevada,  we  saw,  has 
invested  such  portion  of  her  special  funds  as  has  not  gone  into  her 
own  state  loans,  in  State  of  Massachusetts  bonds,  principally,  and 
she  has  only  followed  precedent.  Savings  banks  and  other  fiduciary 
institutions  are  almost  always  buying  in  this  restricted  market. 
But  the  most  insatiable  demand  of  all  is  from  sinking  funds,  by 
which  states,  in  purblind  folly,  becoming  debtors  to  themselves, 
hope  to  raise  up  the  security  for  their  bonds  by  its  own  bootstraps. 
State  sinking  funds  almost  always  pay  more  dearly  for  the  bonds 
of  their  own  state  than  the  market  warrants.  When,  shortly  after 
the  "  silent  panic  "  of  March,  1907,  New  York  State  went  into  the 
market  with  $5,000,000  50-year  3s  it  was,  of  course,  in  the  knowledge 

1  The  Bonds  of  the  Southern  States,   New  York,  1870. 


STATE  BONDS:  THE  ELEMENTS  OF  SECURITY      157 

that  the  great  bulk  of  the  bonds  would  be  bought  by  the  State 
Comptroller.  Otherwise  the  issue  could  not  have  been  floated, 
since  outside  bids  were  received  for  only  $300,000.  Buyers  for 
trusts  or  for  personal  account  who  mistake  this  artificially  created 
clearness  for  security,  and  who  meet  the  price,  are  not  making  the 
most  of  their  opportunities. 

460.  If  the  price  for  state  bonds  is  prejudiced  by  an  artificial 
demand  it  is  also  sustained  at  present  by  a  limited  supply, — by  the 
widespread  reluctance  of  the  commonwealths  to  incur  debt  beyond 
the  needs  of  the  year.  This  reluctance  is  finding  expression  in  the 
entire  abstinence  of  the  eighteen  states  from  funded  "  foreign " 
debt,  in  the  gradual  amortization  of  the  debts  of  other  states,  and  in 
the  growing  sentiment  in  favor  of  constitutional  debt  limitations 
and  inhibitions.  All  in  all,  therefore,  it  is  safe  to  say  that,  though 
one  has  to  pay  dearly  for  state  loans,  the  chances  for  severe  loss 
through  decline  in  price  in  the  near  future  are  much  less  than  in  the 
case  of  government  bonds.  This  of  course  is  but  the  market  aspect 
of  the  increasing  security,  both  sentimental  and  material,  behind 
the  loans  of  the  commonwealths. 

461.  Bond  Characteristics.  There  are  no  accidental  characteris- 
tics of  these  bonds  as  a  class,  worthy  of  special  mention.  Con- 
sidering the  comparative  paucity  of  the  supply  a  great  variety  of 
requirements  as  to  form,  denomination,  interest  rate,  duration, 
etc.,  can  be  met.  Registered,  coupon,  and  interchangeable  bonds 
are  all  to  be  had,  and  in  every  usual  denomination  from  $50  to 
$5,000  and  up.  Many  warrants  and  other  scrip  of  only  a  few 
months'  duration  are  always  outstanding.  Many  of  the  older 
loans  mature  conveniently  in  the  next  few  years;  and  for  long 
bonds,  New  York  Canal  Improvement  3s  have  50  years,  and  the 
Virginia  "  Centuries  "  still  82  years  to  run,  and  there  are  not  a 
few  others.  A  large  and  increasing  proportion  of  state  bonds  is 
exempt  from  taxation,  and  this  fact  has  hitherto  proved  a  strong 
inducement  to  trust  fund  purchase.  However,  the  extension  of  laws 
exempting  municipals  from  taxation  will  in  part  remove  this  at- 
traction from  state  bonds. 

462.  Conclusion.  If  a  somewhat  extended  treatment  has  been 
accorded  state  bonds, — perhaps  more  than  the  subject  at  this  day 
seems  to  warrant,  be  it  said  that  many  of  the  principles  can  be 
conveniently  carried  over  to  the  other  classes  of  tax-secured  bonds 
which  we  shall  now  consider.  But  more  to  the  point:  If  the  men 
of  Lombard  and  Wall   Streets,  and  countless  other  bond  buyers, 


158      STATE  BONDS:  THE  ELEMENTS  OF  SECURITY 

had  taken  the  same  pains  in  1870  or  thereafter  to  acquaint  them- 
selves with  the  components  of  state  credit,  and  of  the  errors  of 
the  legislatures  and  invest  ing  public  iu  the  preceding  generation, 
that  we  have  taken  for  both  generations  and  for  our  own,  fewer  loans 
would  have  been  floated  and  less  state  paper  would  now  repose  in 
ancient  pigeonholes. 


*»• 


CHAPTER  XV 
COUNTY  BONDS 

463.  The  Municipal  Division  of  Tax-Secured  Bonds.  Upon  entering 
the  subject  of  County  Bonds  we  have  done  with  the  governmental 
division  of  tax-secured  issues,  or  Civil  Loans,  and  have  taken  up 
the  municipal  division.  The  line  of  separation  is  very  distinct. 
Government  securities,  whether  federal  or  state,  rest  immediately 
upon  the  good  faith  of  the  obligor.  Creditors  of  states,  other  than 
states  themselves,  have  almost  no  redress  at  law,  and  absolutely 
none  without  the  virtual  consent  of  the  defendant  state.  This 
republican  country  did  not  inherit  in  its  common  law  the  im- 
memorial principle  of  monarchy:  "The  King  can  do  no  wrong;" 
but  in  overriding  by  Constitutional  amendment  the  ruling  of  the 
United  States  Supreme  Court  that  a  state  could  be  sued  by  a 
citizen  of  another  state,  it  surrendered  this  portion  of  its  demo- 
cratic birthright  for  what,  in  the  light  of  history,  many  would  call 
the  pottage  of  state  sovereignty.  History  has  not  dealt  so  ironically 
with  our  municipalities.  Although  legislatures  have  sometimes 
made  the  attempt,  no  state  has  openly  permitted,  or  can  permit, 
its  municipalities  to  evade  any  part  of  their  legal  debt.  To  do  so 
would  be  to  infringe  upon  the  Federal  Constitution  which  pro- 
hibits the  impairment  of  the  obligation  of  contracts.  Therefore 
there  is  no  theoretical  relief  from  unwelcome  debt  for  the  political 
subdivisions.  An  individual  or  a  private  corporation  may,  in  cer- 
tain circumstances,  incur  debt,  and  then,  before  the  law,  be  released 
from  the  obligation.  But  not  so  a  municipal  corporation.  There 
is  no  bankruptcy  court  nor  bankruptcy  law  for  municipal 1  debtors. 

464.  Since,  now,  all  municipalities,  in  contradistinction  to  sov- 
ereign governments,  are  amenable  to  justice  and  equity  vested  in 
the  law,  and  the  law,  in  turn,  is  created  and  exercised  by  higher 
authority  than  the  municipality,  or  even  than  the  state,  a  somewhat 

1  The  several  states  and.  their  legislatures  are  somewhat  at  variance  upon  the 
use  of  the  word  municipal  and  its  derivatives;  and  in  bond  parlance  the  term  is 
none  too  explicit.  In  this  book  it  has  been  used  for  the  most  part  in  its  broadest 
sense,  as  pertaining  to  all  the  civil  divisions  of  a  state. 

159 


160  COUNTY  BONDS 

different  set  of  conditions  affect  the  security  for  municipal  obliga- 
tions from  that  affecting  government  obligations;  or  at  least,  if  the 
various  conditions  are  the  same,  their  relative  influence  and  im- 
portance are  greatly  altered. 

465.  Characteristics  of  the  Municipal  Division.  In  Government 
Bonds,  federal  or  slate,  we  found,  good  faith  was  the  one  great 
essential.  Perhaps  in  only  two  instances  were  state  loans  made  in 
good  faith  which  could  not  be  repaid  because  of  actual  inability; 
and  he  would  be  a  pessimist  indeed  who  believed  the  material  re- 
sources of  any  state  could  be  so  depleted  in  the  future  as  to  compel 
default  on  anything  like  present  acknowledged  indebtedness.  In 
Municipal  Bonds,  however,  good  faith  is  not  theoretically  of  that 
supreme  importance,  for  there  is  remedy  at  law  which  usually 
proves  adequate.  The  cases  are  innumerable  in  which  state  courts, 
or  on  failure  of  these,  federal  courts,  have  come  to  the  relief  of 
bondholders  when  municipalities  have  attempted  to  cheat.  In 
Municipal  Bonds  one  must  first  satisfy  himself  of  the  financial  com- 
petency of  the  issuing  bod}',  that  the  law  may  not  withhold  relief 
for  want  of  wealth  to  tax,  for  the  financial  future  of  all  munici- 
palities, unlike  that  of  states,  is  by  no  means  reasonably  assured. 
And  secondly,  one  must  seek  security  in  the  issue  itself,  must  make 
certain  of  a  bond's  validity,  that  in  want  of  good  faith  he  may  have 
tbe  law  at  his  service.  Lastly,  he  may  weigh  the  evidences  of  good 
faith,  by  the  laws  and  record  of  the  municipality,  and  of  the  state  in 
which  it  is  situated,  and  also  by  the  attitude  of  the  courts  of  juris- 
diction. In  these  ways  lie  may  ascertain  the  degree  of  danger  from 
dishonesty.  This,  then,  is  tbe  order  of  investigation  for  municipal 
issues : — financial  competency,  validity,  and  good  faith, — whereas 
in  State  Bonds  it  is  good  faith,  competency,  and  validity.  This 
difference  of  standing  in  law,  and  diminished  importance  of  good 
faith  as  compared  with  financial  competency  and  validity,  draw 
together  for  study  in  common  the  obligations  of  the  lesser  political 
divisions.  ' 

466.  Therefore  it  is  that  the  bonds  of  counties,  parishes,  town- 
ships, cities,  towns,  villages,  boroughs,  districts,  precincts,  etc., 
etc.,  are  logically  grouped  together  and  often  entitled  municipals, 
whether  the  entity  of  the  issuing  authority  arises  from  incorpora- 
tion, either  by  general  or  special  act  of  legislature,  or  by  act  of 
city  council.  Further  subdivision  of  Tax  Bonds,  or  Civil  Loans,  is 
quite  arbitrary,  and  merely  a  matter  of  convenience.  It  is  usually 
based  on  the  political  nature  of  the  issuing  body,  for  the  character 


COUNTY  BONDS  161 

and  purpose  of  the  flotation  are  largely  determined  by  the  character 
of  the  municipality  and  the  purpose  for  which  it  was  created. 
Since  the  city  (or  town)  is  the  most  important  of  these  political 
units,  the  bonds  of  cities  and  towns  are  called  Municipals  Proper, 
and  it  is  under  the  chapter-head  of  City  and  Town  Bonds  that  the 
principles  that  govern  the  municipal  group  will  receive  their  fullest 
treatment.  Accordingly  the  other  members  of  the  group  will  be 
discussed  only  along  their  lines  of  divergence  from  the  City  and 
Town  type. 

467.  The  Economic  Function  of  the  County.  The  largest  political 
subdivision  of  the  state  is  usually  the  county.1  The  importance  of  the 
county  as  a  civil  division  varies  considerably  in  the  several  states. 
In  Connecticut,  where  the  town  is  the  civil  unit,  from  which  are 
made  the  grand  lists  for  state  as  well  as  for  municipal  tax,  one 
seldom  hears  of  county  bonds,  for  the  part  of  the  county  in  the 
state's  political  organization  is  not  important.  Connecticut  is  one 
of  the  original  states, — as  a  colony  one  of  the  earliest  settled;  its 
population  is  comparatively  dense;  its  ten  cities  and  many 
towns  are  well  scattered,  and  properly  act  as  administrative  cen- 
ters. In  Kansas,  and  in  other  states  of  the  high  plains  region, 
on  the  other  hand,  the  county  usually  seems  to  be  the  major  civil 
unit,  and  county  loans  appear  to  exceed  for  the  most  part,  both  in 
number  and  in  value,  the  loans  of  the  included  cities  and  towns. 
In  these  states  of  enormous  area  and  sparse  population  the  in- 
terests of  a  large  part  of  the  people  are  agrarian  interests;  legis- 
lation and  expenditure  which  have  to  do  with  the  raising  of  cattle 
and  crops  and  their  transportation  by  road  and  rail  to  market, 
are  of  utmost  moment.  Counties  of  this  sort  have  therefore  obli- 
gated themselves  for  the  construction  of  turnpikes  and  bridges, 
and  above  all,  for  railroads;  and  in  common  with  counties  every- 
where, for  those  general  instruments  of  county  administration; 
court  house,  jail,  and  poor  farm. 

468.  The  Range  of  Quality  in  County  Loans.  *As  one  travels  it  is 
a  journey  from  Kansas  to  Connecticut:  representative  in  some 
minds  of  the  former  distance  between  Kansas  and  Connecticut  mu- 
nicipal credit.  Between  the  two  there  is  a  wide  range  of  qual- 
ity in  civil  loans;  and  the  range  in  county  bonds  is  as  great 
as  that  in  any  other  kind,  although  the  legitimate  purposes  of  issue 
are  few.  There  are  counties  that  are  merely  bad  lands,  creations 
of  the  surveyor;  counties  rich  in  mineral  wealth;  counties  without 
1  In  Louisiana  the  county-equivalent  is  usually  called  the  "  parish." 


162  COUNTY  BONDS 

railroad  transportation;  inland  counties,  worthless  without  drain- 
age or  irrigation;  counties  embracing  a  dozen  cities  and  towns; 
metropolitan  counties  coextensive  with  a  great  city.  For  the  loans 
of  all  of  these  we  must  organize  a  criticism  sufficiently  catholic  to 
appreciate  justly  each  and  every  kind. 

Material  Assets 

469.  The  County  Statement.  Our  first  business  in  County  Bonds, 
as  in  all  Municipal  issues,  is  with  the  financial  competency  of  the 
municipality.  To  that  end  a  circular,  offering  County  Bonds,  will 
have  upon  it  a  statistical  statement,  furnishing  us,  probably,  with 
the  county's  Real  and  Assessed  A7aluation,  Gross  (or  Total),  and 
Net  Debt,  Population,  and  perhaps  Tax  Rate.  These  facts  are  very 
useful  in  determining  the  value  of  the  security,  but  not  one  bond 
buyer  in  a  multitude  is  able  to  interpret  them.  Let  us  take  them 
up  in  their  logical  order.     First  the  tax. 

470.  The  Tax  Power  and  Its  Limitation.  The  immediate  security 
for  all  Civil  Loans  is  the  tax-power;  but  although  the  tax-power 
is  directly  dependent  on  the  various  assets,  it  may  not  be  possible 
to  exercise  it  to  its  full  capacity  because  of  artificial  restrictions. 
We  have  deprecated  these  restrictions,  in  the  preceding  pages,  for 
their  artificiality;  maintaining  that  restriction  should  be  put  not 
upon  the  very  organ  by  which  the  amortization  of  debt  is  accom- 
plished, but  rather  upon  the  debt  itself;  and  the  objection  holds  for 
county,  as  well  as  state  tax-limitations.  By  her  constitution  Ala- 
bama in  this  way  restricts  the  county  tax  for  all  purposes  t<<  \  of  1 
per  cent,  of  the  assessed  valuation,  or  $5.00  a  thousand ;  and  Kentucky 
likewise.  Kentucky  very  naturally  permits  her  cities  and  towns 
greater  leeway.  They  may  tax  themselves  from  $7.50  to  $15.00  a 
thousand  of  their  assessed  valuation,  according  to  population.  Ala- 
bama restricts  all  municipalities  and  Arkansas  her  counties,  to  $5.00. 
Arkansas  does  not  restrict  her  other  municipalities.  Oklahoma  re- 
stricts her  counties  to  $8.00  and  other  municipalities  more  or  less 
according  to  their  importance.  Apart  from  any  legal  complications 
which  this  strange  sort  of  limitation  may  arouse,  it  will  be  hard 
to  convince  the  skeptical  layman  that  if  calamity  should  overtake 
county  or  town,  and  the  tax-burden  become  harassing,  the  as- 
sessors might  not  yield  to  the  temptation  to  lower  the  assessed 
valuation,  and  thereby  cut  into  the  annual  tax  and  prevent  the 
satisfaction  of  municipal  contracts;  for  it  must  not  be  forgotten 


COUNTY  BONDS  163 

that  the  current  expenses  of  the  municipality  have  the  right  of  way 
over  the  discharge  of  municipal  obligations.  This  base  resort  of 
untrustworthy  municipalities  is  made  impossible  by  the  constitu- 
tions of  California,  Georgia,  Idaho,  Illinois,  Iowa,  Kentucky,  Michi- 
gan, Missouri,  New  Hampshire,  North  Dakota,  Oklahoma,  Pennsyl- 
vania, South  Dakota,  Texas,  and  Wisconsin.  In  Illinois  the  pro- 
vision reads  as  follows :  "  Any  county,  city,  school  district,  or  other 
municipal  corporation  incurring  any  indebtedness  as  aforesaid, 
shall,  before  or  at  the  time  of  doing  so,  provide  for  the  collection 
of  a  direct  annual  tax  sufficient  to  pay  the  interest  on  such  debt 
as  it  falls  due,  and  also  to  pay  and  discharge  the  principal  thereof 
within  twenty  years  from  the  time  of  contracting  same." 

471.  Although  constitutional  limitation  of  the  tax  rate  for  coun- 
ties is  rare,  statutory  limitation  is  by  no  means  uncommon.  West 
Virginia  limits  her  counties  to  6-10  of  1  per  cent.,1  or  f  6.00  a  thou- 
sand; and  New  Jersey,  on  a  scale  down  to  an  ultimate  $5.00  a 
thousand.  If  the  statute  limits  the  tax  rate  in  a  general  municipal 
taxing  act,  i.e.  if,  in  the  limited  tax  rate,  are  included  the  taxes  for 
all  public  purposes  (and  this  is  usually  the  case),  it  may  prove  dan- 
gerous, for  current  expenses  are  or  can  be  made  very  elastic,  and  an 
expansion  of  them  to  defraud  would  be  hard  to  prove  at  law.  In 
times  past  (e.g.  in  Missouri),  taxes  raised  in  virtue  of  a  special 
bond-enabling  act  have  come  into  contact  with  the  general  statutory 
limitation  of  tax  rate,  and  the  special  bond-tax  has  been  required 
to  come  within  the  limits  of  the  tax  rate  for  all  municipal  purposes. 
But  the  Supreme  Court  of  Missouri  has  recently  relinquished  this 
construction  to  the  benefit  of  all  municipal  bondholders. 

472.  The  Tax  Rate.  To  attempt  to  draw  conclusions  from  the 
tax  rate  of  a  county  is  well-nigh  hopeless  without  the  possession  of 
facts  never  found  on  a  bond  circular.  The  tax  rate  of  Hartford 
County,  Connecticut,  is  25  cents  per  $1,000,  and  of  Adams  County 
Ohio,  $17.35.  Surely  the  burden  borne  by  Adams  County  property- 
holders  is  not  seventy  times  as  great!  Such  absurd  discrepancies 
are  seldom  found  in  city  and  town  statements.  The  cause  must  lie 
in  the  nature  of  the  civil  division.  Counties  and  districts  of  all 
sorts  will  be  found  to  make  returns  like  these,  utterly  at  variance 
with  any  principle  of  uniformity  in  administration. 

473.  To  a  large  extent  the  lower  tax  may  be  said  to  obtain  in 

1  This  statutory  limitation  is  more  stringent  than  that  of  the  Constitution  of 
1872,  which  set  the  maximum  county  tax  rate  at  95-100  of  1  per  cent.,  or  $9.50 
a  thousand. 


k;4  county  bonds 

counties  with  the  higher  valuation.  Concentration  of  wealth 
economizes  the  expense  of  wealth's  maintenance.  Yet  little  satis 
faction  will  be  got  from  the  principle  in  this  form.  Perhaps  the 
only  form  of  the  principle  worth  application  to  county  tax  rates 
is  this:  "  Municipal  Counties,"  i.e.  counties  containing  one  or  more 
cities,  can  maintain  a  tax  rate  justifiably  lower  than  "  Rural  Coun- 
ties," siiue  in  municipal  counties  the  city  or  cities,  by  municipal 
tax,  may  carry  the  burden  of  public  improvements.  Therefore, 
although  the  rural  Adams  County,  Ohio,  has  a  tax  rate  of  $17.35, 
Summit  County,  Ohio,  has  a  tax  of  only  $2.35,  because  Akron,  the 
county  seat,  comes  to  its  relief  with  a  valuation  of  over  $25,000,000 
to  tax  at  the  rate  of  $32  per  thousand.  Occasionally  one  finds  a 
city  like  Lynchburg,  Virginia,  which  does  not  pay  county  taxes. 
In  such  a  case  the  rate  for  the  county  will  be  higher  than  it  would 
otherwise  be,  and  to  all  intents  the  county  could  be  classified  as  a 
rural  county. 

474.  Under  this  condition  too,  the  assessed  valuation  and  all 
other  components  of  the  county  statement  should  be  presented 
minus  the  non-participating  city's  share.  What  has  just  been  said 
applies  only  in  part  to  the  municipal  county  of  Suffolk,  Massachu- 
setts, which  includes  Boston,  Chelsea,  Revere,  and  Winthrop.  By 
a  contract  between  these  cities  and  towns,  dating  back  to  1822 
(when  Winthrop  and  Revere  were  a  part  of  Chelsea),  only  Boston 
is  liable  to  taxation  for  any  county  purposes  until  the  legislature 
shall  otherwise  order;  and  in  return,  Boston  has  all  interest  in  and 
jurisdiction  over  the  real  and  personal  estate  of  the  county.  All 
statistical  considerations  for  these  municipalities  should  be  gov- 
erned accordingly. 

It  is  not  always  evident  what  is  included  in  the  tax  rates  as 
presented  by  county  officials.  One  should  make  certain  whether 
the  state  tax  has  been  deducted  and  the  special  taxes  for  schools  or 
institutions,  if  there  are  any  such.  When  the  statement  is  worded 
"  Total  Tax "  these  generally  are  included.  On  the  other  hand, 
if  the  county  is  coextensive  with,  or  overlapping  any  other  civil 
division,  such  as  a  levee  district,  one  should  make  sure,  in  com- 
puting the  annual  burden,  that  the  divisional  taxes  are  included, 
for  the  same  property  must  bear  the  two  or  more  imposts. 

475.  Assessed  Valuation.  In  presenting  the  assessed  valuation 
the  bond  circular  is  not  liable  to  mislead,  seriously,  in  its  state- 
ment. This  valuation  will  be  the  total  of  the  assessed  valuations 
of  the  constituent  civil  divisions,  including  cities,  etc.,  irrespective 


COUNTY  BONDS  165 

of  the  method  of  appraisal.  An  exception  should  be  taken  when  a 
civil  division,  like  Lynchburg  mentioned  above,  does  not  bear  its 
share  of  the  county  tax.  Any  unusual  situation  like  this  at  Lynch- 
burg is  to  be  avoided,  because  of  the  likelihood  that  the  principles 
arising  may  not  have  received  adjudication  in  the  courts.  No  effort 
is  made,  as  a  rule,  to  indicate  in  the  county  statement  whether  the 
ratio  of  assessed  valuation  to  real  valuation  is  approximately  the 
same  for  the  county  as  the  average  ratio  of  the  included  towns,  etc., 
for  it  must  be  understood  that  the  ratios  often  differ,  and  for  per- 
fect results  in  comparison  need  adjustment  such  as  is  given  by  a 
board  of  equalization.  In  considering  assessed  valuation,  as  well 
as  tax  rate,  debt,  or  population,  we  should  constantly  keep  in  view 
the  character  of  the  county : — whether  it  is  "  municipal  "  or  "  rural," 
for  the  amount  of  the  assessed  valuation  is  not  the  onlv  significant 
feature,  but  the  ratio  it  bears  to  the  real  net  debt. 

476.  Other  Resources :  Secondary  Income.  Counties,  and  "  taxing 
districts  "  such  as  we  treat  in  Chapter  XIX,  are  not  so  favorably 
situated  as  states  and  cities,  in  regard  to  secondary  income.  All 
civil  divisions  are  on  the  same  plane  of  possibility  respecting 
revenue  from  sinking  funds,  but  the  nature  of  counties  and  districts 
precludes  them  from  extended  proprietary  ownership  (as  distin- 
guished from  governmental  ownership)  of  revenue-producing  prop- 
erty. And  in  those  states  in  which  the  public  property  of  the  mu- 
nicipality is  seizable  for  public  debt,  the  value  of  such  county  and 
district  property,  except  in  the  case  of  school  districts,  is  relatively 
small. 

477.  County  Debt.  In  a  large,  rough  way,  the  figures  for  assessed 
valuation,  as  presented,  suffice  for  ordinary  investigation.  But  the 
county  debt-statement,  as  customarily  understood,  is  utterly  mis- 
leading. There  is  nothing  else  in  the  county  statement,  or  in  the 
usual  statement  of  any  other  civil  division,  which  misrepresents  the 
facts  as  this.  Not  that  the  debt-statement  is  literally  incorrect, 
for  this  is  not  the  case,  but  that  the  ordinary  inferences  cannot  be 
drawn  from  it.  If  the  assessed  valuation  of  a  county  is  the  sum 
of  the  assessed  valuations  of  its  subdivisions,  then  the  real  debt  of 
the  county  should  be  the  sum  of  the  debts  of  the  county  and  its  sub- 
divisions ;  and  there  is  no  fairness  in  exhibiting  the  ratio  of  county 
debt  to  county  valuation,  unless  our  methods  of  arriving  at  the  totals 
of  debt  and  valuation  are  the  same.  As  a  matter  of  fact,  however, 
by  county  debt  we  do  not  mean  the  real  debt  of  the  county,  but  only 
the  debt  of  the  political  unit  called  county,  irrespective  of  the  debts 


166  COUNTY  BONDS 

of  the  included  political  units.  It  is  unlikely  that  this  method  of 
computing  county  debt  arose  from  any  nice  observance  of  the  letter 
of  the  law,  but  rather  from  the  ease  with  which  the  nominal  or 
direct  county  debt-statement  was  to  be  secured,  as  compared  with 
the  necessity  of  search  in  ascertaining  the  real  debt  of  the  county; 
and  furthermore,  because  the  county  debt-statement  is  much  more 
presentable  when  construed  literally. 

478.  The  Real  Debt  of  Municipal  Counties.  It  is  plain  that  the 
discrepancy  between  real  and  direct  county  debt  is  of  most  import- 
ance in  municipal  counties,  for  it  is  in  these  that  the  bulk  of  indirect 
or  municipal  debt  is  to  be  found.  Perhaps  as  good  an  illustration 
as  any  is  Allegheny  County,  Pennsylvania.  Allegheny  County  in- 
cludes, among  other  cities,  the  great  manufacturing  centers  of  Pitts- 
burg, Allegheny  City, —  (these  two  now  consolidated),— McKees- 
port,  Braddock,  Wilkinsburg,  Homestead,  and  Duquesne.  The 
assessed  valuation  of  this  county  is  nearly  equal  to  the  combined 
assessed  valuations  of  Maine,  New  Hampshire,  and  Vermont,  and 
in  general  is  greater  than  that  of  thirty-two  of  the  forty-six  states.1 
On  Feb.  1,  1908,  it  amounted  to  $1,032,267,850.  The  "  net  debt  " 
at  that  time  was  $8,040,548,  or  considerably  less  than  1  per 
cent.  The  bonds  of  Allegheny  County  are  considered  with  good 
reason  as  one  of  the  strongest  of  investments.  But  it  is  a  matter 
of  conjecture  to  what  extent  this  "  less  than  1  per  cent."  influences 
the  purchase  of  the  bonds.  Certainly  under  customary  methods  of 
exhibiting  debt-statements,  no  other  form  of  presentation  would  be 
fair  to  the  county.  If,  however,  the  sounder  custom  prevailed  of 
exhibiting  the  real  net  debt  of  the  county,  i.e.  the  total  net  debt  of 
the  county  and  its  subdivisions,  the  investor  would  have  a  truer 
idea  of  his  security,  and  the  bonds  of  Allegheny  County  would 
appreciate,  on  comparison  of  its  real  net  debt  with  that  of  other  mu- 
nicipal counties,  for  the  net  debts  of  Pittsburg,  Allegheny  City, 
etc.,  are  low,  as  city  debts  go. 

479.  With  the  cooperation  of  the  officials  it  would  not  ordinarily 
be  difficult  to  compute  the  real  net  debt  of  a  county.  It  is  a  simple 
sum  in  addition;  and  it  would  have  the  inestimable  advantage  of 
allowing  fair  comparisons  with  the  debt-statements  of  the  other 
municipal    divisions.      In   financial    statements,    as    in   everything 


1  This  is  the  reading  of  the  usual  bond-circular.  We  violate,  here,  our  princi- 
ples of  comparison,  by  not  reducing  the  assessed  valuations  to  a  common 
denominator  of  real  valuation. 


COUNTY  BONDS  167 

else,  the  whole  truth  in  the  end  is  simpler  than  the  half  truth,  and 
works  for  the  best  interests  of  every  one  concerned.1  In  want  of 
the  figures  for  real  debt  it  is  best  to  appraise  the  material  credit 
of  municipal  counties  at  somewhat  less  than  the  credit  of  the  lead- 
ing municipality  or  municipalities  in  the  county.  This  rule  will 
have  exceptions.  Many  would  except  Allegheny  County.  The 
bonds  of  Essex  County,  New  Jersey,  because  of  peculiar  local  con- 
ditions, often  sell  to  slightly  better  advantage  than  the  bonds  of 
Newark,  which  is  situated  in  it.  Yet,  in  general,  the  principle 
holds  good,  particularly  for  "  metropolitan  counties,"  i.e.  counties 
which  are  coextensive  with,  or  wholly  dominated  by,  the  great  cities 
of  the  country.  Other  influences  of  course  are  at  work  upon  county 
credit  beside  the  debt  ratio,  and  this  matter  will  be  taken  up  in 
greater  detail  when  we  come  to  speak  in  particular  of  municipal 
and  metropolitan  counties. 

480.  The  Real  Debt  of  Rural  Counties.  Although,  as  we  said  in 
the  last  paragraph,  the  discrepancy  between  real  and  direct  county 
debt  is  greatest  in  municipal  and  metropolitan  counties,  it  is  likely 
to  arise  in  rural  counties  as  well.  Rural  counties,  in  part  or  in 
whofl,  may  be  situated  in,  or  may  include,  special  assessment  dis- 
tricts for  road  improvement,  for  the  installation  of  conduit  water 
supply,  and  for  the  reclamation  of  land  by  drainage  or  irrigation. 
Since  the  taxing  districts  created  for  these  purposes  are  usually 
supported  by  levies  only  on  the  land  benefited,  it  often  happens  that 
rural  counties  have  heavier  tax-burdens  on  some  parts  of  their 
territory  than  on  others ;  and  this  fact  is  not  likely  to  appear  in  a 
statement  of  the  county  debt.  Still,  since  the  financing  of  rural 
counties  is  so  much  simpler  and  without  sophistication,  their  fiscal 
condition  is  generally  set  forth  in  its  right  light.  Cass  County,  In- 
diana, for  illustration,  has  a  "  general,"  or  direct  debt  of  f  71,680 ;  but 
owing  to  a  peculiar  decision  of  the  State  Supreme  Court  (which  has 
analogues  in  one  or  two  other  states),  the  improvement  of  roads 
becomes  a  township,  rather  than  a  county,  affair;  and  therefore 
townships  of  Cass  County  have  issued  $196,387  in  bonds  payable 
in  each  case  by  levies  on  the  township  improved.  Yet  since  these 
bonds  are  really  a  contingent  debt  of  the  county,  they  appear,  as 
they  should,  in  the  total  debt  as  exhibited  by  the  county. 

481.  Since,  now,  the  statement  of  a  county's  net  debt  may  be  so 
wide  of  the  mark,  we  must  not  permit  ourselves  the  luxury  of 

1  For  the  application  of  the  "  real  debt "  principle  to  city  credit,  see  the  next 
chapter  under  the  caption,  "City  Debt"    (§§  59&-600). 


168  COUNTY  BONDS 

debt-comparisons,  as  between  county  and  county,  but  especially 
as  between  county  and  city,  without  making  due  allowance  for 
what  may  be  called  "  included  debts."  To  do  so  would  be  to  in- 
dulge in  the  same  sort  of  fallacy  that  we  exposed  in  the  comparison 
of  assessed  valuations,  in  the  preceding  chapter. 

482.  Contingent  Debt;  Quasi  County  Bonds.  The  indirect  sort  of 
debt  represented  by  the  Township  Bonds  of  Indiana  counties  is  not 
the  only  kind  of  county  contingent  debt.  Indiana  will  serve  for 
example  as  well  as  any  other  state.  Sullivan  County  has  no  direct, 
or  "general"  debt;  but  with  an  assessed  valuation  of  $20,480,315, 
it  has  a  contingent  debt  of  $7G4,SGG,  consisting  of  road,  ditch  (or 
drainage),  and  levee  bonds.  St.  Joseph  County,  with  a  direct 
debt  of  about  the  same  amount,  has  a  few  ditch  bonds  outstanding. 
That  these  indirect  or  contingent  obligations,  with  their  less  assured 
status  in  the  eyes  of  the  law,  are  held  in  lower  esteem,  is  to  be  seen 
in  this  instance  in  the  interest  rate.  All  the  other  bonds  of  St. 
Joseph  County  are  3^s,  4s,  or  4-|s ;  but  the  ditch  bonds  are  6s.  West- 
chester County,  New  York,  recently  issued  some  4|s  of  doubtful 
genealogy.  It  was  the  general  opinion  of  banking  houses  that  these 
were  only  quasi  county  bonds, — a  sort  of  special  assessment  issue, 
secured  by  taxation  against  only  such  portions  of  the  county  as 
would  be  benefited  by  the  improvement;  although  the  county  itself 
undertook  to  make  the  collection  and  father  the  transaction.  As 
a  result  only  three  bids  were  received  for  the  bonds,  and  these  only 
at  a  lower  figure  than  Westchester  had  a  right  to  expect  had  they 
been  a  direct  obligation. 

483.  To  what  degree  quasi  county  bonds  are  really  a  contingent 
debt  of  the  county  depends,  to  a  certain  extent,  on  the  nature  of 
the  bond,  but  more,  on  the  attitude  of  the  courts  of  jurisdiction. 
The  federal  courts,  outside  of  the  7th  Circuit,  and  most  of  the 
state  courts  (with  the  particular  exception  of  Illinois),  hold  the 
including  municipality  liable  for  these  Special  Assessment  bonds. 
The  subject  will  receive  more  extended  treatment  in  the  chapter  on 
District  Bonds,  under  the  caption  Special  Assessment  Bonds. 

484.  Debt  Limitations.  A  partial  recognition  of  the  fact  that  the 
direct,  or  even  the  direct  and  contingent,  county  debt  is  but  a  part 
of  the  real  debt,  is  seen  in  the  stringent  limitations  to  the  county 
debt,  as  compared,  often,  with  the  limitations  to  other  kinds  of 
municipal  debt.  Again  we  may  look  to  Indiana.  Although  the 
other  municipalities  of  the  state  are  permitted  to  incur  funded 
obligations  to  the  extent  of  2  per  cent,  of  the  assessed  valuation, 


COUNTY  BONDS  169 

counties  for  the  most  part  are  limited  to  not  much  more  than  1 
per  cent.,  and  certain  kinds  of  debt-creating  activities  which  are 
permitted  the  other  civil  divisions,  are  forbidden  the  counties.  We 
find  the  same  sort  of  discrimination  in  Utah,  where  cities  and  towns 
are  given  a  nominal  debt-limit  of  4  per  cent.,  but  counties  are 
limited  to  2  per  cent.  In  Oregon  the  framers  of  the  constitution 
of  1857  restricted  the  debt  of  any  county  in  that  state  to  f  5,000; 
but  left  the  terms  of  restriction  for  the  other  civil  divisions  to  the 
discretion  of  future  legislatures.  Although  an  inadjustable  re- 
striction such  as  Oregon's  is  highly  undesirable,  and  encourages 
resort  to  subterfuges  to  circumvent  the  constitution,  nevertheless 
it  is  a  recognition  of  the  peculiar  relation  which  exists  between  a 
county's  net  debt  and  that  of  its  included  municipal  divisions. 

These  that  we  have  discussed  are  the  leading  features  of  the 
usual  county  statements  which  differ  from  those  of  city  or  town. 
For  further  details  the  investor  or  student  is  referred  to  the  corre- 
sponding paragraphs  in  the  chapter  on  City  and  Town  Bonds. 
The  second  half  of  the  chapter  on  State  Bonds  also  may  be  helpful. 

Validity 

485.  Having  disposed  of  financial  competency, — the  first  con- 
sideration in  ascertaining  the  credit  of  a  county,  in  so  far  at  least 
as  it  is  to  be  ascertained  from  statistics, — we  are  prepared  for  the 
succeeding  topic,  validity. 

486.  With  the  gradual  fixation  of  municipal  bond  law,  and  of 
bond  recitals,  and  of  methods  of  issue  under  trust  company  super- 
vision and  certification,  the  best  informed  of  bond  buyers  may 
scarcely  hope,  by  taking  further  thought,  to  safeguard  himself  to 
any  greater  extent  than  will  a  reliable  banking  house  that  serves 
him.  If  buying  refunding  loans  he  may  look  up  the  character  and 
history  of  the  loan  refunded,  and  accept  no  bonds  that  refund  an 
issue  concerning  which  there  has  been  trouble,  as  in  the  Muhlen- 
burg  County,  Kentucky,  Refunding  5s  and  the  Hinsdale  County, 
Colorado,  Refunding  4s.  Loans  refunding  issues  validated  by  the 
United  States  Supreme  Court  might  be  an  exception  to  this  rule, 
having  been  approved  by  the  court  of  last  resort;  but  even  then,  as 
in  Pima  County,  Arizona,  Territorial  Funding  3s,  other  grounds  of 
trouble  might  arise. 

487.  Furthermore,  he  may  restrict  his  purchases  to  loans  created 
for  objects  properly  accomplished  and  paid  for  by  county  organiza- 


170  COUNTY  BONDS 

fcion.  He  will  accept  as  proper  purposes  of  issue  when  statutory 
authority  is  conferred,  loans  for  courthouses  and  jails,  since  the 
county  is  a  judicial  unit  ;  also  for  schoolhouses,  asylums,  poor  farms, 
roads,  culverts,  and  bridges;  and  in  most  states  except  Michigan  for 
railroad  aid.  Irrespective  of  state  laws  he  will  be  suspicious  of  loans 
issued  in  aid  of  state  institutions  or  private  corporations  other  than 
railroads.  He  will  refuse  county  bonds  issued  to  build  state  normal 
schools,  armories,  sugar  mills,  water,  gas,  and  electric  light  works, 
or  bonds  to  defray  any  other  expenditures  not  in  strict  accord  with 
a  county's  functions.  Above  all  things  he  will  read  with  utmostj-are 
the  statement  upon  the  instrument  he  buys,  remembering  that  in 
properly  drawn  bonds  the  municipality  that  issues  them  is  estopped 
from  many  causes  of  illegality  by  the  very  recital.  Had  holders  of 
Green  County,  Kentucky,  Railroad-Aid  bonds  observed  this  pre- 
caution before  buying,  they  would  not  now  be  cherishing  them  as 
priceless  mementos  of  the  blue-grass  region. 

488.  Yet  it  does  not  follow,  because  a  bond  has  been  issued  in 
an  irregular  manner,  that  the  courts  will  permit  its  repudiation,  as 
Hitchcock  County,  Nebraska,  found  out  in  1905  when  the  United 
States  Circuit  Court  of  Appeals  decided  that  "  although  all  the  re- 
quirements of  the  law  may  not  have  been  observed,  that  fact  is  not 
sufficient  ground  for  the  repudiation  of  the  bonds  when  they  come 
into  the  hands  of  an  innocent  person  for  value,  provided  there  has 
been  no  legal  obstacle  to  the  county  officers'  complying  with  the 
requirements  of  the  law."  However,  it  is  better  to  be  sure  than  to 
be  sorry;  and  the  best  way  to  avoid  invalidity  in  municipal  issues 
i^  to  buy  them  only  of  the  most  responsible  banking  houses,  and  if 
the  issue  is  new  and  untried,  only  when  certified  to  by  a  respon- 
sible trust  company,  and  when  accompanied  by  a  favorable  legal 
opinion  from  responsible  bond  attorneys.  But,  after  all,  this  cau- 
tion applies  to  city  and  district  bonds  as  well  as  to  county. 

489.  The  Partition  and  Annexation  of  Counties.  There  is  one 
phase,  however,  of  the  legal  situation  in  counties, — particularly 
large  counties  in  the  still  unsettled  West  and  Southwest, — which 
sometimes  causes  disquiet  to  holders  of  this  class  of  issues.  The 
large  counties  of  Idaho,  Arizona,  New  Mexico,  and  Montana, — 
counties,  some  of  them  greater  in  area  than  the  smaller  New  Eng- 
land states, — which  have  arrived  at  that  stage  of  development  de- 
manding a  more  intensive  agriculture,  often  become  too  unwieldy 
for  the  proper  exercise  of  county  functions  under  the  conflicting 
demands  of  diversified  interests.     This  is  especially  the  case  when 


COUNTY  BONDS  171 

the  surface  of  the  land  in  one  part  of  the  county  has  been  re- 
trieved by  irrigation,  or  drainage,  or  otherwise,  and  the  remainder 
is  in  pasturage.  Then  the  variance  of  two  types  of  people  may 
make  a  slight  political  separation  advisable,  as  in  the  separation  of 
Latah  County  from  Nez  Perces  County,  Idaho.  The  adjustment  and 
resurvey  of  state  and  county  boundary  lines  is  another  cause  of 
the  partition  of  counties. 

490.  Quite  the  opposite  phenomenon,  the  annexation  of  counties, 
is  accomplished  in  the  interest  of  various  political  plans,  not  only 
in  the  West,  but  in  the  East,  also.  Redisricting,  as  a  political 
vote-getting  device,  is  at  least  as  early  with  us  as  1812,  for  it  was 
in  that  year,  when  Elbridge  Gerry  was  Governor  of  Massachusetts, 
that  the  Americanism,  gerrymandering,  was  coined  to  describe  it. 

491.  The  partition  and  annexation  of  counties  (and  the  prin- 
ciple holds  good  for  all  municipalities)  need  not  and  usually  do 
not  cause  serious  disturbance  of  bond  security.  When  a  state  legis- 
lature "cTia^g^Th^eouotynboundaries  it  may  reapportion  the  in- 
debtedness in  any  way  that  seems  proper,  provided  that  in  so  doing 
it  does  not  impair  the  obligation  of  the  municipal  contract,  i.e. 
seriously  impair  the  bond  security.  The  difficulties  arise  from  the 
fact  that  oftentimes  the  legislatures  are  remiss  in  their  duties,  and 
altogether  neglect  to  redistribute  the  old  debt.  In  lieu  of  specific 
legislative  apportionment  the  general  principle  holds,  that,  when 
in  the  partition  of  a  county,  the  original  municipality  is  not  abol- 
ished, the  obligations  of  that  county  remain  with  it,  and  do  not 
hold  on  the  segregated  territory.  And  in  like  manner,  when 
territory  has  been  annexed  to  a  county,  the  annexed  territory 
is  relieved  of  its  obligations  under  the  old  municipality  and 
assumes  those  of  the  county  of  which  it  has  become  a  part.  This 
situation  is  not  often  met.  However,  in  1893  portions  of  Mora 
County,  New  Mexico,  were  reincorporated  in  new  counties  under 
legislative  direction. 

492.  When,  however,  by  the  partition  of  a  county,  two  or  more 
eounties  are  formed,  and  the  old  county  abolished,  the  apportion- 
ment of  the  debt,  in  want  of  legislative  provision,  will  be  on  the 
broad  principles  of  equity  established  for  these  cases  by  the  United 
States  Supreme  Court ;  the  debt  will  be  distributed  pro  rata,  accord- 
ing to  the  relative  taxable  valuations  of  the  segregated  territories. 
For  a  case  of  extinction  see  the  former  county  of  Alturas,  Idaho. 

493.  But  by  far  the  commonest  kind  of  partition  is  that  in  which 
the  remnant  territory  retains  its  municipal  identity,  and  the  frag- 


172  COUNTY  BONDS 

ment  becomes  a  new  county.  Bond  law,  in  this  circumstance,  would 
be  more  susceptible  of  dispute.  As  a  rule  the  indebtedness  has 
received  legislative  adjustment.  Otherwise  it  generally  remains 
the  sole  obligation  of  the  parent  county;  and  its  offshoot  escapes 
the  debt.  But  this  need  not  disturb  the  bondholder.  Under  the 
law  of  contracts  he  has  recourse  upon  the  new  county  in  default 
of  the  old,  in  so  far  as  the  new  county  was  part  of  the  old  at  the 
time  of  the  contract.  Those  interested  will  find  material  for  study 
of  this  class  of  indebtedness  against  the  counties  of  Stevens,  Wash- 
ington; Spartanburg,  South  Carolina;  Ada,  Idaho;  Missoula  Park, 
and  Deer  Lodge,  Montana ;  and  Apache  and  Yapavai,  Arizona. 

494.  Doubtless  it  would  surprise  many  people  to  know  with  what 
little  friction  in  regard  to  the  reapportionment  of  indebtedness, 
the  partition  of  counties  has  been  accomplished.  There  is  reason 
for  this.  But  it  is  merely  public  good-fortune  that  in  the  parti- 
tion  of  states  or  of  territories  to  form  states  (Massachusetts,  Vir- 
ginia, Dakota,  etc.)  the  notorious  "  West  Virginia  Certificates" 
represent  the  only  loss  to  bondholders.  Theoretically  the  danger 
of  loss  from  ownership  of  state  bonds,  in  partition,  is  much  greater, 
for  it  is  not  possible  to  compel  the  adjudication  of  disputes.  But 
for  county  obligations  a  board  of  apportionment,  or  an  arbitration 
committee,  with  legislatively  derived  powers,  can  enforce  its  find- 
ings, and  the  federal  courts  can  give  adequate  relief  in  equity.  No- 
where is  that  illustrated  to  better  advantage  than  in  Pima  County, 
Arizona,  which,  with  a  heavy  load  of  unsettled  railroad-aid  debt 
hanging  over  it,  was  able  to  accomplish  the  segregation  of  a  portion 
of  its  territory  to  form  the  new  county  of  Santa  Cruz,  by  releasing 
Santa  Cruz  from  its  share  of  Pima  County's  debt  on  the  surrender 
by  Santa  Cruz  County  of  the  equivalent  in  its  own  bonds. 

495.  Occasionally  the  partition  of  a  county  has  weakened  the 
standing  of  bondholders  in  case  of  previous  default.  In  1905  a 
writ  of  temporary  mandamus,  issued  to  the  Commissioners  of  Santa 
F6  County,  ordering  them  to  levy  a  tax  to  amortize  some  defaulted 
bonds  of  1882,  was  resisted  by  the  taxpayers,  partly  on  the  ground 
"  that  considerable  of  the  area  and  property  of  Santa  F6  County 
at  the  time  of  the  default  and  the  first  mandamus  has  since  been 
annexed  to  Rio  Arriba  and  Torrance  Counties,  and  that  much  new 
property  has  been  placed  upon  the  assessment  books  since  the  de- 
fault." 1    In  want  of  reliable  information  we  hazard  the  conjecture 

1  The  Denver  Republican,  August  24,  1905.  (Quoted  in  the  Commercial  and 
Financial  Chronicle,  Vol.  LXXXI,  p.   1059.) 


COUNTY  BONDS  173 

that  this  partition  was  instigated  for  the  very  purpose  of  avoiding 
payment,  and  that  for  this  reason  the  bondholders  will  ultimately 
be  sustained  by  the  courts.  It  seems  not  so  much  an  exception 
to  the  usual  outcome  of  county  partition,  as  an  exemplar  of  in- 
eradicable bad  faith, — a  part  of  the  topic  to  which  we  have  now 
arrived.  Various  offers  of  compromise  have  been  refused  by  Santa 
F6  County  bondholders.  The  outcome  of  this  controversy  is  awaited 
with  interest. 

Good  Faith 

496.  It  is  to  be  regretted  that  a  study  of  county  conditions  does 
not  yield  us  as  satisfactory  assurances  for  the  future  regarding 
good  faith  as  regarding  validity.  In  relating  the  history  of  state 
bonds,  the  unpleasantness  of  dwelling  upon  past  repudiation  was 
mitigated  by  the  unmistakably  sound  condition  of  present  state 
credit,  and  by  the  safeguards  of  constitutional  restriction  built 
against  future  temptation  and  unwisdom.  It  is  true  that  we  have 
a  right  to  believe  that  never  again  will  counties  of  the  United 
States  be  brought  to  face  a  combination  of  circumstances  so  un- 
favorable to  civil  credit  as  those  of  the  forties  and  seventies;  and 
we  have  the  satisfaction  of  knowing  that  at  the  costly  tutelage 
of  experience,  the  people  of  this  country,  as  a  whole,  have  learned 
the  simple  financial  lesson  that  it  is  cheaper  to  pay  a  debt  than  to 
disown  it.  But  still,  we  have  to  face  the  fact  that  many  munici- 
palities have  outstanding  perfectly  valid  debts,  obligations  in  ethics 
as  well  as  in  law,  which  they  can  pay,  and  won't  pay,  and  intend 
never  to  pay.  The  most  flagrant  instances  are  usually  in  rural 
counties,  for  the  reasons  we  shall  set  forth. 

497.  The  Extent  and  Cause  of  County  Repudiation.  During  the 
Beconstruction  Period,  before  the  vogue  of  reclamation  and  special 
assessment  districts,  and  other  newfangled  devices  for  debt-making, 
the  political  unit  that  suffered  most  from  war  and  the  expansion 
of  credit,  was  the  county, — especially  the  rural  county.  Man  for 
man  and  dollar  for  dollar,  no  other  civil  division  at  that  time  lay 
so  utterly  prostrate  as  the  rural  county.  The  typical  rural  county, 
in  the  nature  of  the  case,  was  in  the  West  and  South.  Men  from 
Eastern  cities,  with  a  little  capital,  more  imagination,  and  most 
shrewdness, — with  well-drawn  charts  and  easy  speech, — inveigled 
the  farmers  into  bonding  their  municipalities  to  help  construct 
railroads  by  which  their  produce  might  reach  better  markets. 
Sometimes  these  roads  were  built;  but  in  the  flimsiest  manner, 


174  COUNTY  BONDS 

and  did  not  pay,  and  were  discontinued.  Sometimes  they  were 
built  in  part; — a  very  small  part.  Often  they  were  not  even  sur- 
veyed. Meanwhile  the  bonds  had  been  sold  and  somebody  had 
pocketed  the  proceeds. 

498.  The  extent  to  which  practices  similar  to  these  prevailed  in 
the  less  settled  parts  of  the  country,  seems  incredible  in  this  day 
and  generation.  To  attribute  them  altogether  to  the  wiles  of  East- 
ern capitalists,  or  to  the  stupidity  of  the  municipalities,  is  to  see  but 
one  side  of  a  complex  situation.  If  the  East  was  "  criminally  " 
sharp,  the  West  was  "  criminally "  dull.  If  loans  were  secured 
from  counties,  et  al.,  for  railroads  it  was  never  intended  to  build, 
loans  were  floated  by  counties  which  they  never  intended  to  pay. 
But  wherever  the  burden  of  the  fault  lay,  the  results  are  plain 
enough:— from  $12,000,000  to  $18,000,000  of  municipal  bonds,  it 
is  estimated,  were  scaled  in  Nebraska,  Kansas,  and  Eastern  Dakota 
alone,1  and  throughout  the  new  country  repudiation  and  default 
became  almost  the  rule,  rather  than  the  exception.  The  extent  of 
this  repudiation  of  county  and  municipal  debts,  the  greater  part 
of  which  occurred  in  the  Reconstruction  Period,  is  not  known,  but 
has  been  estimated  to  be  about  $1,000,000,000 !  "  The  most  prolific 
field  for  municipal  delinquencies  has  been  in  and  near  the  naturally 
rich  Mississippi  valley,  from  Duluth  to  Mobile.  ...  Of  over  three 
hundred  municipalities  in  Illinois,  more  than  one-third  refused 
payment  of  bonds.  Of  one  hundred  counties,  townships,  and  cities 
issuing  bonds  in  Missouri,  nine- tenths  have  defaulted.  Kansas' 
record  is  somewhat  better,  but  humiliating;  while  the  bonded  com- 
munities of  Arkansas  have  been  unanimous  in  attempting  repudia- 
tion." 2 

499.  The  effect  of  this  dispensation  upon  the  county  was  most 
sinister.  County  organization  and  administration  are  very  close 
to  the  people.  State  and  city  government  is  more  complex,  requires 
a  higher  order  of  intelligence,  and  is  therefore  at  further  remove 
from  the  aspiration  and  attainment  of  the  average  citizen.  But 
then  and  now,  any  decent  man,  any  respected  farmer,  might  leave 
the  plow  like  Cincinnatus,  and  become  County  Commissioner.  Or 
more  likely  than  not,  he  might  be  at  the  same  time,  both  plow- 
man and  Commissioner.     Into  such  an  order  of  things  let  now  the 

1  Moody's  Magazine,  February,  1906:  "The  West's  Readjustment  of  Indebted- 
ness," C.  M.  Harger. 

2  The  Xorth  American  Review,  August,  1884,  pp.  127-144  and  563-579.  (Ab- 
stracted by  A.  D.  Chandler.) 


COUNTY  BONDS  175 

leaven  of  corruption  work, — whether  it  be  the  bedazzlement  of  un- 
paid-for  improvements,  or  the  spirit  of  blind  retaliation  aroused  by 
contracts  paid  for,  in  a  sense,  but  unfulfilled, — and  the  untutored 
multitude  and  their  county  administrators  are  aroused  from  the 
smug  complacency  of  their  foolish  debt-making,  and  in  primitive 
passion  deny  their  obligations  at  all  costs  and  come  what  will. 

500.  The  soberer  minds  which  usually  prevail  in  city  govern- 
ments incline  toward  a  wiser  application  of  the  power  of  creating 
debt,  and  more  legal  procedure  in  case  of  the  violation  of  con- 
tracts. Then,  on  the  part  of  the  citizens,  as  the  intricacies  of  city 
accounting  are  less  in  reach  of  average  understanding,  and  the 
taxpayers  are  not  in  voting  majority,  as  in  the  county,  a  mis- 
application of  a  municipal  loan  creates  less  turbulence,  and  repudia- 
tion is  less  often  the  resort.  This  is  why  the  good  faith  of  counties, 
especially  rural  counties,  is  not  to  be  so  implicitly  relied  on  as  that 
of  cities  and  towns.  Changes  of  county  administration,  too,  some- 
times bring  more  epochal  results,  because  there  is  not  that  mo- 
mentum and  continuity  of  policy  which  is  fostered  by  a  partly 
permanent  civil  organization  such  as  we  find  in  a  large  city  govern- 
ment. Hence  they  say  it  was  that  in  Buncombe  County,  North 
Carolina  (of  Congressional  renown),  f  100,000  Asheville  and  Spar- 
tanburg Bailroad  bonds  were  repudiated  during  a  brief  reign  of 
the  Populists  in  1898.  Buncombe  County,  of  which  Asheville,  with 
a  population  at  that  time  of  about  12,000,  is  the  seat,  could  hardly 
have  been  called  a  wholly  rural  county;  but  it  is  in  North  Carolina; 
and  in  a  state  with  a  record  like  that  of  North  Carolina,  a  county 
would  have  to  contain  a  large  population  to  escape  the  suspicion 
of  being  rural  in  its  credit  characteristics. 

501.  The  Persistence  of  County  Repudiation.  In  presenting  the 
extent  and  causes  of  county  default  it  has  not  been  explained  why 
the  spirit  of  opposition  to  law  should  persist  to  the  present  time. 
It  is  quite  natural  that  states  saddled  with  a  tremendous  and  in- 
valid debt,  sometimes  through  no  fault  of  the  people  at  large,  should 
bury  it  by  constitutional  amendment,  and,  being  under  no  com- 
pulsion except  that  of  public  opinion,  should  be  reluctant  or  un- 
willing to  resurrect  it.  It  is  not  so  evident  why  counties,  such  as 
Macon  and  St.  Clair,  Missouri,  should  be  willing  to  bear,  for  thirty 
to  thirty-five  years,  the  odium  of  repudiating  their  obligations. 
But  the  causes,  for  the  most  part,  lie  in  the  conditions  already 
outlined.  The  notorious  case  of  St.  Clair  County  will  serve  ex- 
cellently for  illustration. 


176  COUNTY  BONDS 

502.  In  1870,  St.  Clair  County,  .Missouri,  issued  $231,000  bonds 
in  aid  of  the  Tebo  and  Neosho  Railroad  (now  a  part  of  the  Missouri, 
Kansas,  and  Texas).  The  section  contracted  for  was  never  built, 
and  the  county  stopped  payment  on  its  bonds.  The  bondholders 
brought  suit  and  secured  judgment,  but  the  county  officers  have 
ever  since  refused  to  execute  the  judgment  by  making  a  tax- levy  to 
discharge  the  debt.  Year  after  year  the  officials  spent  their  terms 
in  jail  as  the  result  of  defiance  of  the  law, — although  now  we  under- 
stand, they  (literally)  take  to  the  tall  timbers  straightway  after 
election,  instead;  and  to  this  day  county  repudiation  is  the  election 
issue.  Such  a  condition  of  things  betrays  a  mania,  an  obsession, 
in  the  minds  of  the  people,  which  is  impossible  in  a  community  with 
cosmopolitan  habits  of  thought.  The  assessed  valuation  of  St. 
Clair  County  is  not  much  over  $1,000,000,  so  that  this  debt  of 
$231,000,  with  its  accumulations  (its  interest-rate  is  10  per  cent), 
if  paid  in  full,  would  fall  very  heavily  upon  the  tax-paying  voters. 

503.  A  "  modern  instance "  of  wholly  uncalled-for  and  unjusti- 
fiable repudiation,  which  arises  out  of  those  very  conditions  which 
we  have  described  as  obtaining  in  rural  counties,  is  that  of  Hender- 
son County,  North  Carolina.  Henderson  County  had  outstanding, 
in  the  eighties,  some  railroad  bonds  on  which  it  was  perfectly 
able  to  pay,  and  had  paid,  interest  charges  regularly.  Upon  the 
celebrated  decision  of  the  State  Supreme  Court  invalidating  the 
railroad-aid  bonds  of  Wilkes  and  Stanley  Counties,  the  authorities 
of  Henderson  County  promptly  followed  suit  in  repudiation.  Al- 
though the  United  States  courts  reversed  this  decision  in  the  cases 
of  Wilkes  and  Stanley  Counties,  and  sustained  the  bondholders, 
still,  it  is  to  be  seen  that  county  credit  cannot  bear  its  own  weight 
in  the  weaker  states.  Credit  among  them  is  not  always  voluntary, 
nor  even  "enlightened  self-interest,"  but  merely  compulsory;  credit, 
there,  is,  or  was,  not  a  matter  of  ethics,  but  of  necessity  and  of 
law.  The  issue  in  these  weaker  states  is  still  validity,  as  we  saw 
in  the  chapter  on  State  Bonds,  in  the  case  of  Pitt  County,  North 
Carolina. 

504.  Now  there  is  one  very  important  aspect  of  county  credit, 
brought  to  mind  by  these  cases  of  St.  Clair  and  Macon,  which  has 
not  been  mentioned  as  yet,  and  that  is  the  simplicity  of  county 
debenture  requirements.  Proper  objects  for  public  expenditure  we 
found  to  be  very  few  in  the  nature  of  county  organization;  and  the 
cost  of  these  would  be  comparatively  small.  Therefore  if  it  ever 
became  convenient  to  repudiate  an  issue,  a  county, — a  rural  eounty, 


COUNTY  BONDS  177 

particularly, — is  not  under  the  same  necessity  as  a  city  to  reckon 
the  future  cost  of  the  loss  of  its  credit.  Probably  we  shall  not  see, 
for  many  a  year,  a  public  offering,  successfully  placed,  of  bonds  of 
the  defaulting  counties  of  Macon  and  St.  Clair,  Missouri;  Green 
and  Muhlenburg,  Kentucky;  Lake  and  Hinsdale,  Colorado;  and 
Wilkes  and  Onslow,  North  Carolina. 

505.  In  closing  this  subject  of  the  good  faith  of  counties  it  is 
only  fair  to  say  that  the  history  of  recent  defaults  is  more  prom- 
ising. Occasionally  we  meet  with  an  instance  like  that  of  Jefferson 
County,  Washington,  which  has  temporarily  scaled  its  debt,  or  the 
interest  on  it,  from  actual  inability  to  pay  in  full.  No  one  can 
analyze  the  financial  statement  of  this  county  and  feel  that  the 
bondholders  have  a  real  grievance.  They  should  have  studied  the 
conditions  more  thoroughly  before  purchasing.  The  attitude  of 
Lawrence  County,  South  Dakota,  is  reassuring.  In  1907  Lawrence 
County  was  obliged  to  default  temporarily  on  an  issue  of  $235,000 
of  5s  which  matured  during  the  panic.  The  whole  amount  has  been 
taken  care  of  to  the  entire  satisfaction  of  the  bondholders.  About 
$100,000  has  been  retired,  and  the  balance  has  been  extended  at  6 
per  cent,  (with  privilege  of  redemption)  for  five  years.  Such  an 
exhibition  of  good  faith  should  materially  help  the  credit  of  that 
community. 

506.  Rural  Versus  Municipal  Counties.  In  everything  relating  to 
the  administration  and  credit  of  counties,  we  have  had  to  dis- 
tinguish between  those  which  were  rural  and  those  municipal.  The 
discrimination  has  been  so  pointed  that  little  more  need  be  said 
here.  A  buyer  of  bonds  should  never  consider  county  bonds  with- 
out having  the  distinction  firmly  in  mind.  Those  features  which 
we  have  observed  to  militate  against  county  loans  as  a  class  are 
accentuated  in  rural  county  issues,  and  those  features  which  pre- 
possess in  favor  of  city  loans  as  a  class  are  accentuated  in  munici- 
pal county  issues. 

507.  Even  when  the  county  administration  is  entirely  distinct 
and  apart  from  the  administration  of  the  included  city  or  cities, 
the  influence  of  the  more  important  city  interest  is  bound  to  tell 
in  favor  of  better  fiscal  methods,  greater  sobriety  in  debt-incur- 
rence,  less  eccentricity  in  all  relations  which  affect  bondholders. 
Particularly,  having  need  of  the  good-will  and  confidence  of  in- 
vestors for  future  issues  within  the  corporate  limits,  municipal 
counties  will  see  to  the  prompt  payment  of  debts.  Of  the  many 
counties  in  the  United  States  with  defaulted  obligations  as  yet 


178  COUNTY  BONDS 

unadjusted,  very  few  indeed  can  properly  be  called  municipal,  I.e. 
containing  a  city  or  town  of  25, 000  population,  let  us  say. 

508.  Metropolitan  Counties.  There  is  little  likelihood  of  over- 
estimating the  influence  of  strong  cities  and  towns  upon  the  good 
faith  of  the  counties  in  which  they  are  situated.  If  the  principle 
holds  at  all  it  can  be  carried  to  the  extreme: — if  there  is  security 
in  a  cosmopolitan  population,  in  extensive  establishments,  in  the 
presence  of  public  institutions,  and  in  talented  civic  administra- 
tion,— other  things  being  equal, — then  the  larger  the  population, 
the  more  numerous  the  establishments,  the  greater  the  institutions, 
the  more  businesslike  the  administration, — the  better  shall  be  the  se- 
curity behind  the  loans.  So  bond  investors  are  justified  in  their 
marked  preference  for  what  we  here  choose  to  call  "  metropolitan 
county  loans,"  as  distinguished  even  from  municipal  county  loans. 
The  presumption  is  that  the  metropolitan  county  bonds  partake  of 
the  characteristics  of  the  included  great  city  or  cities. 

509.  To  ascertain  in  a  crude  way  to  what  extent  the  interests 
of  the  city  dominate  the  county,  subtract  the  real  (or  in  want  of 
the  real,  the  assessed)  valuation  and  the  population  of  the  city 
from  those  of  the  county  and  observe  what  remains.  This  might  be 
done  with  Seattle  and  Kings  County,  Washington.  In  this  case 
the  ratio  of  assessed  and  real  valuation  being  the  same,  there  is 
no  need  of  figuring  the  real  valuation.  When  there  are  no  constitu- 
tional or  statutory  limitations,  note  also,  the  ratio  of  the  respective 
tax  rates,  having  in  mind  the  things  to  consider  in  tax  rates, — as 
in  Hartford  County,  Connecticut.  When  the  city  tax  rate  is  many 
times  the  county  rate,  very  evidently  the  city  has  assumed  the 
major  portion  of  civic  functions  which  might  otherwise  entail  upon 
the  county ;  and  the  county's  credit  is  to  that  extent  benefited. 

510.  The  connection  between  metropolitan  cities  and  their  coun- 
ties has  become  so  intimate  that  Philadelphia,  St.  Louis,  and  San 
Francisco,  coextensive  with  counties  of  the  same  names,  have  be- 
come practically  merged  with  their  counties,  and  the  counties  un- 
der city  control,  have  no  separate  debt.  The  situation  in  Provi- 
dence is  somewhat  similar.  Providence  County  is  without  debt, 
although  not  coextensive  with  the  city  of  Providence,  and  therefore 
not  under  its  direct  control.  The  bond-buyer  who  wishes  to  pur- 
chase county  obligations  of  the  highest  grade,  will  seek  those  which 
comprehend  great  cities  of  established  credit,  especially  when  the 
statistics  of  the  city  and  its  county  reveal  an  intimacy  of  function 
and  administration,  such  as  is  to  be  observed  in  Seattle  and  Kings 


COUNTY  BONDS  179 

County,  Chicago  and  Cook  County,  Cleveland  and  Cuyahoga  County, 
Albany  and  Albany  County,  and  Boston  and  Suffolk  County. 

511.  Other  County  Bond  Matters.  If  now,  when  investing,  he  re- 
lates the  principles  set  forth  in  this  chapter  with  those  relating  to 
credit  in  general,  which  were  discussed  in  the  preceding  chapter,  and 
with  those  affecting  all  municipal  issues,  which  immediately  follow 
in  the  chapter  on  City  and  Town  Bonds,  he  will  have  a  good  working 
knowledge  to  assist  in  the  right  choice  of  county  loans.  Let  him 
remember  that  although,  as  a  class,  County  Bonds  are  inferior  to 
City  and  Town  Bonds,  they  are  superior  to  District  Bonds,  and  be- 
long to  the  great  division  of  United  States  Civil  Loans,  the  strong- 
est kind  of  investment  security  bought  by  the  American  people. 


CHAPTER  XVI 
CITY  AND  TOWN  BONDS:  MUNICIPAL  ASSETS 

512.  Municipal  Corporations  Proper.  By  city  and  town  bonds  are 
meant,  generally,  the  funded  obligations  of  municipal  corporations 
proper,  i.e.  of  those  political  subdivisions  of  the  state  which  are 
voluntary  corporations,  as  distinguished  from  the  subdivisions 
which  are  created  more  specifically  at  the  instance  of  legislatures, 
or  of  common  councils,  and  are  called  quasi-municipal  corporations, 
being  involuntary  in  their  creation.  Counties,  townships,  and  the 
other  various  taxing  districts  are  usually  involuntary  corporations 
in  the  eyes  of  the  law;  but  cities  and  incorporated  villages  are 
always,  and  towns  are  generally,  voluntary  bodies,  or  municipal 
corporations  proper,  and  their  funded  loans  may  therefore  be  called 
Municipals  Proper.  More  particularly,  then,  we  deal  in  this 
and  the  following  two  chapters  with  the  bonds  of  cities  and  of 
incorporated  towns  and  villages. 

513.  This  two-fold  distinction  between  municipal  corporations 
and  their  securities  is  by  no  means  universal.  The  courts,  and  the 
legislatures  of  the  states,  do  not  always  adhere  to  it.  But  it  is 
nevertheless  a  real  distinction,  which  we  have  met  and  shall  meet 
again,  especially  in  discussing  proper  purposes  of  bond  issue  and 
their  relation  to  legality.  Nevertheless  most  of  the  principles 
which  will  be  laid  down  in  this  discussion  of  City  and  Town  Bonds 
are  applicable  to  the  whole  division  of  Civil  Loans. 

514.  Within  the  subdivision  of  Municipal  Corporations  Proper, 
covered  by  this  chapter,  there  are  no  thorough-going  distinc- 
tions. The  same  principles  are  applicable  to  incorporated 
towns  and  villages,  as  to  cities.  Many  a  town  or  village  of  this 
sort  is  larger  and  more  important  than  some  individual  cities, 
especially  in  certain  groups  of  states.  The  "  city  "  of  Williston, 
North  Dakota,  had  a  population  in  1900,  according  to  the  federal 
census,  of  763;  and  the  "city"  of  Fort  Pierre,  South  Dakota,  of 
395,  and  Ventnor  City,  New  Jersey,  in  1905,  of  110.  The  "  town  " 
of  Brookline,  Massachusetts,  had  a  population  of  27,792  in  1910, 
and  an  assessed  valuation  in  1906  of  over  $100,000,000.     The  Con- 

180 


CITY  AND  TOWN  BONDS:  MUNICIPAL  ASSETS      181 

necticut  towns  outrank  the  cities  in  many  respects, — quite  apart 
from  wealth  or  population.  By  the  Revised  Statutes  of  1902  the 
towns  may  incur  debt  without  limit,  under  a  general  bond-enabling 
act;  but  the  cities  have  not  this  privilege,  unless  by  special  act 
or  charter. 

515.  Size,  wealth,  and  prospects,  then, — in  other  words  those 
conditions  which  make  for  financial  competency  are  paramount; 
and  although  financial  legislation  often  discriminates  between 
cities,  towns,  and  villages,  as  such,  it  is  usually  on  the  tacit 
assumption  that  this  is  the  usual  order  of  their  size  and  wealth, 
and  of  their  competency.  So  in  some  states  the  discrimination  is 
carried  further,  and  statutes  regulating,  for  instance,  the  authority 
and  extent  of  debt-incurrence  classify  even  cities  according  to  their 
population. 

516.  By  the  constitution  of  1851  the  General  Assembly  of  Ohio 
organized  the  cities  of  that  state  into  two  classes  of  three  and  four 
grades,  respectively,  according  to  population,  to  "  restrict  their 
power  of  taxation,  assessment,  borrowing  money,  contracting  debts, 
and  loaning  their  credit,  so  as  to  prevent  the  abuse  of  such  power." 
Kentucky,  in  the  constitution  of  1891,  limited  particularly  the 
debt-making  power  of  the  political  subdivisions  by  a  double  distinc- 
tion: she  recognized  the  kind  of  municipal  corporation  and  also 
its  number  of  inhabitants.  Cities  in  that  state  with  population  of 
over  15,000  might  incur  debt  to  the  extent  of  10  per  cent,  of  their 
assessed  valuation ;  cities  and  towns  of  3,000  and  over  were  limited 
to  5  per  cent.,  and  cities  and  towns  of  less  than  3,000,  to  3  per 
cent.;  but  counties  and  taxing  districts  and  otlier  municipalities 
were  limited  to  2  per  cent. 

517.  This  recognition  by  constitution  and  statute  of  the  import- 
ance of  financial  competency,  as  indirectly  indicated  by  statistics  of 
population,  brings  us  again  to  the  lines  of  investigation  we  are  pur- 
suing for  municipal  issues.  We  have  already  found  that  the  three 
principal  factors  which  make  for  the  security  of  municipal  bonds,  in 
the  order  of  their  importance,  are  financial  competency,  validity,  and 
good  faith. 

Financial  Competency:  Material  Assets 

518.  The  City  Statement.  The  public  who  buy  city  and  town 
bonds,  as  well  as  county  and  other  municipal  issues,  depend  for 
information  as  to  financial  competency  almost  entirely  upon  the 
statistical   statement   of   the   bond-house   circular.     Of   all    these 


1S2      CITY  AND  TOWN  BONDS:  MUNICIPAL  ASSETS 

municipal  statements,  the  city  statement  gives  the  truest  indication 
of  material  conditions  because  the  records  for  cities  are  likely  to 
be  more  complete  and  are  revised  at  more  frequent  intervals,  and 
for  other  reasons  which  we  shall  come  to  presently.  Furthermore 
these  records  are  more  accessible,  since  they  are  to  be  obtained, 
not  only  in  the  city's  offices,  but  also  in  periodical  publications, 
notably  the  Commercial  and  Financial  Chronicle.  The  records  of 
the  smaller  quasi-municipalities,  and  taxing  districts,  especially 
when  not  largely  bonded,  are  sometimes  inaccessible  to  any  but 
a  most  persistent  investigator.  Apparently,  in  the  estimation  of 
local  officers,  the  smaller  the  community,  and  the  more  dubious 
its  standing,  the  more  sacrosanct  its  books.  If  one  wishes  to  go 
behind  the  most  recent  printed  records,  or  if  no  records  are  to  be 
found,  his  usual  resource  is  one  or  another  of  the  several  municipal 
officers,  according  to  the  kind  and  size  of  the  municipality,  and  to 
the  nature  of  the  inquiry.  But  it  is  important  to  remember  that 
no  municipality  is  in  any  way  responsible  for  the  correctness  of  the 
statement  issued;  and  the  truth  or  falsity  of  the  statement  has 
no  bearing  upon  the  legality  of  any  bond  issue.  Not  often,  however, 
has  this  immunity  worked  detriment  to  the  creditors  of  the  mu- 
nicipality. 

519.  The  Tax  Rate.  The  circular,  offering  a  municipal  loan,  will 
sometimes  mention  the  tax  rate  of  the  community.  Considered 
apart  the  rate  means  little  or  nothing.  Of  all  the  items  on  the 
circular  this  is  the  most  difficult  of  interpretation.  And  yet  it 
indicates  to  what  extent  the  municipality  is  drawing  annually 
upon  its  resources  to  sustain,  protect,  and  improve  its  social  and 
corporate  life.  In  analyzing  the  rate,  when  this  is  possible,  one 
must  make  sure  that  it  does  not  include  too  much  or  too  little. 
"  Tax  Rate  "  may  mean  the  total  imposition,  including  state  and 
county  levies;  "City  Tax,"  "Town  Tax,"  "Village  Tax,"  should 
mean  the  tax  of  only  the  local  community,  which  is  usually,  but 
not  always,  the  major  part  of  the  whole.  "  Total  Tax  "  is  what 
its  name  signifies. 

520.  For  purposes  of  comparison  it  will  be  desirable  to  separate 
the  city  tax  from  the  county  and  state  taxes.  On  the  same  grounds 
any  tax  rebate  should  be  deducted.  In  some  places  this  rebate  is 
very  considerable.  Savannah,  Georgia,  is  not  very  exceptional  in 
allowing  10  per  cent.  On  the  other  hand  there  will  often  be  dis- 
trict and  special  assessment  taxes  of  one  sort  or  another,  which 
are  not  exercised  by  the  municipality  as  a  corporation,  and  are  not 


CITY  AND  TOWN  BONDS:  MUNICIPAL  ASSETS      183 

included  even  in  the  "Total  Tax;"  but  which  are  imposts,  never- 
theless, upon  such  a  large  portion  of  the  property  within  the  cor- 
porate limits  that  they  cannot  legitimately  be  overlooked.  It  is 
not  to  be  expected  that  those  whose  interest  it  is  to  make  a  most 
satisfactory  exhibit  will  go  out  of  their  way  to  include  indirect 
taxes;  but  since  any  tax  is  a  drain  on  resources,  and  since  our 
usual  object  in  analyzing  the  tax  is  to  discover  the  amount  of  the 
drain,  we  must  include  and  examine  any  special  taxes  we  find. 
Two  or  three  years  ago  Coffeyville,  Kansas,  had  a  total  tax  of  f  70.50 
on  a  25  per  cent,  assessment.  But  in  this  tax  was  not  included 
the  special  levy  on  the  special  debt  incurred  for  sewers  and  roads, 
although  this  debt  is  nearly  as  large  as  the  general  debt.  And 
moreover  there  is  a  Coffeyville  School  District  which  had  a  school 
tax  of  $24.  The  fact  that  the  School  District  has  different  bound- 
aries from  Coffeyville  proper  does  not  prevent  the  school  tax  from 
falling  on  a  large  majority  of  Coffeyville  taxpayers,  whose  real 
"  total  "  tax  burden  was  well  over  $100  a  thousand,  or  10  per  cent, 
of  the  assessed  valuation,  or  2^  per  cent,  of  the  real. 

521.  Assuming  now  that  one  has  arrived  at  the  real  total  net 
tax,  he  is  justified  in  preferring  a  low  to  a  high  tax.  A  low  tax 
generally  implies  a  sound  financial  condition.  Its  natural  cor- 
relate, if  the  city  or  town  is  economically  run,  is  a  low  percentage 
of  net  debt,  as  in  Lincoln,  Massachusetts,  with  a  tax  of  $7.25  and 
a  bonded  debt  of  about  3  per  cent,  of  the  assessed  valuation.  Con- 
versely, a  high  tax  seems  to  imply  an  unhealthy  condition,  and  a 
high  percentage  of  debt,  as  in  the  village  of  Collinwood,  Ohio,  with 
a  tax  in  1905  (including  the  school  district)  of  $64.30,  and  an 
approximate  total  debt  of  from  20  to  25  per  cent,  of  the  assessed 
valuation.    The  real  valuation  is  not  reported. 

522.  But  the  exceptions  to  these  generalizations  are  so  numerous 
as  to  discourage  any  but  the  studious  from  seeking  their  drift.  As 
we  are  led  to  expect  from  the  law  of  averages,  the  extremes  of 
high  and  low  tax  rates  are  to  be  found,  generally,  in  small  com- 
munities, which,  of  course,  most  acutely  reflect  in  statistics  any 
local  idiosyncrasies  of  administration.  Thus  we  find  in  Rhode 
Island  many  villages  and  towns  with  a  tax  rate  of  under  $10  a 
thousand  on  an  assessed  valuation  of  from  50  to  75  per  cent,  of 
the  real.  But  the  tax  rate  of  Providence  is  $16.50  on  full  valuation ; 
yet  not  over  a  half-dozen  cities  in  the  country  enjoy  as  good  credit. 

523.  Under  the  peculiar  form  of  civil  government  in  Connecti- 
cut, where  the  unit  is  the  town,  and  the  town  often  includes  a  city 


184      CITY  AND  TOWN  BONDS:  MUNICIPAL  ASSETS 

or  a  borough,  the  city  or  borough  tax  may  be  returned  as  separate 
from  the  town,  district,  county,  and  state  tax,  and  therefore  re- 
quire adjustment  to  the  usual  basis  of  rate. 

524.  Another  difficulty  one  often  meets  in  considering  the  tax 
is  a  variation  of  rate  within  the  municipality.  In  cities  that  are 
not  wholly  built  up,  e.g.  those  which  are  coextensive  with  great 
counties,  the  tax  is  sometimes  regulated  to  the  locality  and  to  the 
improvements  installed.  Pittsburg,  Pennsylvania,  has  a  city  tax 
of  $7.50;  but  over  25  per  cent,  of  the  real  estate  is  charged  with 
only  the  rural  tax,  which  is  two-thirds  the  city  tax;  and  about  .G 
per  cent,  of  the  real  estate  has  to  pay  only  the  agricultural  tax, 
which  is  one-third  the  city  tax.  Scranton,  Pennsylvania,  has  about 
the  same  tax  plan,  although  there  is  not  so  much  difference  in  the 
three  tax  rates.  Stamford,  Connecticut,  has  a  system  of  scaled  tax 
rates,  as  also  Seattle,  Washington.  In  Bellingham,  Washington, 
we  find  four  separate  tax  rates,  one  for  each  district  of  the  city. 
But  the  cause  is  slightly  different  from  that  in  the  other  cities 
mentioned  except  Seattle.  Bellingham  is  a  consolidation  of  several 
towns,  and  the  distribution  of  the  tax  burden  in  this  way  prevents 
an  injustice  to  the  districts  which  came  into  the  consolidation. 
Similarly  New  York  has  slightly  different  tax  rates  for  the  four 
boroughs. 

525.  We  have  thus  far  considered  the  tax  rate  in  its  present 
relation  to  the  city  in  which  it  obtains.  Such  consideration  begins 
to  have  value  only  when  made  the  basis  of  comparison.  Compari- 
sons may  be  made  with  the  previous  annual  tax  rates  of  the  same 
municipality,  or  with  the  present  tax  rates  of  other  municipalities 
of  the  same  class  having  other  conditions  as  nearly  analogous  as 
possible.  Better  still,  a  comparison  may  be  made,  in  settled  com- 
munities, of  the  tax  rate  of  a  municipality^,  averaged  over  a  period 
of  years,  with  the  tax  rates  of  similar  municipalities  of  the  same 
class,  averaged  in  the  same  way.  But  the  moment  we  begin  com- 
parisons we  must  remember  our  principles  of  arithmetic;  for  tax 
rates  are  like  fractions: — to  be  compared  they  must  be  reduced 
to  a  common  denominator.  The  common  denominator  of  tax  rates 
is  full  property  valuation  (real  valuation),  and  if  for  no  better 
reason  than  advantages  of  comparison  (since  comparison  is  useful 
to  interests  unrelated  to  the  bond  business),  all  tax  assessments 
throughout  the  country  should  be  on  the  basis  of  full  valuation. 
In  1907  Plattsburg,  New  York,  had  a  tax  of  about  $50;  New  York 
City,  of  about  $15.     But  since  Plattsburg  was  assessed  for  about 


CITY  AND  TOWN  BONDS:  MUNICIPAL  ASSETS      185 

one-third  value  and  New  York  for  full  value  (nominally),  the  bur- 
den on  the  citizens  of  the  town  is  only  a  dollar  or  two  greater. 
It  is  a  pity  that  the  tax  rate  does  not,  of  itself,  show  this.  In 
finance  simplicity  and  excellence  are  very  nearly  synonymous. 

526.  This  common  denominator  of  full  valuation  is  not  necessary, 
of  course,  in  comparing  the  tax-burden  of  a  municipality  with  its 
own  past  rates,  providing  that  during  the  previous  years  the  ratio 
of  assessed  to  real  valuation  has  not  changed.  The  fixed  ratio,  in 
that  case,  is  itself  a  common  denominator.  But  in  order  to  institute 
such  a  comparison  we  must  know  whether  or  not  the  ratio  has  re- 
mained unchanged.  Within  recent  years  there  has  been  a  growing 
tendency,  especially  in  the  East,  to  assess  for  "  fair  cash  value." 
New  York  City  made  the  change  in  1903,  and  as  a  result  the  tax 
rate  dropped  from  about  $23  a  thousand  to  about  $14.50.  Harris- 
burg,  Pennsylvania,  according  to  the  usual  financial  records,  had 
an  assessed  valuation  in  1880  of  $5,384,629,  and  a  tax  rate  of  $37.50. 
In  1889  the  assessed  valuation  had  grown  to  $21,396,240,  and  the  tax 
rate  had  declined  to  $20.50.  In  want  of  definite  knowledge  one 
would  infer  that  at  some  time  between  1880  and  1889  the  same  sort 
of  change  had  taken  place  in  the  assessment  basis  of  Harrisburg 
property.  But  in  1890  the  assessed  valuation  had  decreased  slightly 
(to  $20,412,135),  and  yet  the  tax  rate  dropped  to  $12.25.  Evidently, 
therefore,  other  influences  were  at  work  effecting  these  alterations. 

527.  The  reasonable  increase  in  a  city's  tax  rate  over  a  period 
of  years  is  not  necessarily  an  unfavorable  sign,  any  more  than  is 
a  reasonable  increase  in  debt.  Present  heavy  expenditures  may  be, 
and  now  usually  are,  an  anticipation  of  increased  assets  and 
therefore  of  levy  power.  According  to  the  Census  Bureau,  for  the 
country  at  large  the  increase  in  rate  of  ad  valorem  taxation  from 
1880  to  1902  has  been  about  $2  a  thousand  on  the  estimated  real 
value  of  all  property,  taxed  or  exempt.  It  is  to  be  doubted  if  any 
figures  are  accessible  to  show  the  average  increase  of  the  tax  rate 
for  cities  and  towns,  or  for  municipalities  generally.  The  move- 
ment of  population  toward  cities  and  the  resulting  tremendous 
urban  development  justify  acquiescence  in  an  average  municipal 
increase  far  in  excess  of  that  for  the  country  at  large.  Whether 
any  city  is  exceeding  its  fair  proportion  of  increase,  whatever  that 
may  be,  and  whether  it  is  justified  in  so  doing,  must  be  decided 
by  the  nature  of  its  expenditures,  and  by  the  ease  with  which  it 
can  support  its  mandatory  charges. 

528.  The  necessity  of  a  sui  generis  investigation  of  tax  rates 


ISO      CITY  AND  TOWN  BONDS:  MUNICIPAL  ASSETS 

is  illustrated  in  Pulaski  County,  Arkansas,  which  had  a  floating 
debt  in  1907  of  $103,011  and  a  bonded  debt  of  about  twice  this 
amount,  [nstead  of  issuing  long-term  sinking-fund  bonds  with 
their  comparatively  light  annual  charges,  the  County  elects  (we 
assume,  in  want  of  knowledge  to  the  contrary)  to  unburden  itself 
of  this  floating  obligation  by  heavy  annual  payments.  The  tax  rate, 
which  is  about  $30  a  thousand  on  a  true  valuation,  must  reflect 
this  effort.  We  are  further  assured  as  to  the  motives  of  the 
County  from  the  fact  that  the  bonded  debt  is  being  retired  in  annual 
payments.  Therefore  a  comparison  of  the  County's  tax  rates  over 
a  series  of  years,  or  of  the  present  rates  with  those  of  other  West- 
ern semi-municipal  counties,  would  have  to  take  into  favorable 
consideration  this  serial  repayment  feature  of  its  financing.  A 
tax  rate  which  is  high  because  a  community  is  ridding  itself  rapidly 
of  debt,  really  may  be  low  in  any  true  system  of  municipal  economy. 
A  prospective  purchaser  of  any  new  loan  of  Pulaski  County  may 
well  remember  that  in  seven  years  the  tax  rate  probably  will  be 
relieved  of  all  the  charges  on  the  present  floating  debt  and  on  about 
one-third  of  the  present  bonded  debt. 

529.  It  is  hardly  necessary  to  say  that  most  comparisons  of  the 
tax  rate  of  one  kind  of  political  division  with  another  are  void. 
As  a  rule  the  state  tax  rate  is  the  lowest  of  those  of  the  principal 
civil  units.  Then  in  order  come  the  county  taxing  district,  and  city 
and  town  rates.  The  principal  factors  which  make  for  this  order 
are  the  relative  current  administrative  expenses,  and  the  fixed 
charges  on  the  governmental  "  plant "  per  capita  of  included  popu- 
lation. Constitutions  and  statutes  recognize  this  inequality  in  the 
necessary  expenses  of  the  several  kinds  of  governments,  and  limit 
their  debt-incurring  power  accordingly.  It  was  only  when  this 
principle  became  recognized  that  state  credit  became  sound. 

530.  Furthermore,  interclass  comparisons  of  tax  rates  are  void 
because  the  different  units  have,  in  part,  different  sorts  of  Avealth  as 
taxable  resources.  A  review  of  the  material  assets  of  states  in 
the  chapter  on  State  Bonds  will  recall  to  mind  some  of  these 
differences.  Then  again,  in  isolated  instances,  political  units  have 
cut  themselves  off  from  ready  comparison  with  other  units  of  the 
same  class  by  an  unusual  and  arbitrary  method  of  taxation.  Wil- 
mington, Delaware,  does  not  tax  personal  property.  Personal  prop- 
erty at  best  is  an  obstacle  in  the  path  of  him  who  seeks  to  read 
the  message  of  the  tax  rate.  There  is  little  uniformity  in  the  treat- 
ment of  personal  property,  not  only  among  the  states,  but  within 


CITY  AND  TOWN  BONDS:  MUNICIPAL  ASSETS      187 

a  state.  Massachusetts,  almost  always  progressive  in  matters  of 
political  administration,  has  formed  an  assessors'  association,  one 
of  the  pressing  duties  of  which  will  be  to  better  the  inequalities  and 
injustices  that  arise  from  misuse  of  the  power  to  tax  personal 
property. 

531.    We  have  already  remarked  upon  the  necessity  of  coming 
to  some  conclusion  as  to  what  the  true  tax  rate  really  is.    We  are 
again  reminded  of  this  need  in  attempting  to  compare  the  rates  of 
municipalities  in  different  states.     The  difficulty  is  that  no  rule 
can  be  formulated.    From  the  standpoint  of  the  economist  no  doubt 
the  best  way  to  compute  the  total  tax-burden  upon  the  property 
owner  per  thousand  dollars  of  real  valuation,  rather  than  to  accept 
the  nominal   city  tax,   although   the  bond   attorney,  with   an  eye 
to  legality,  will  scan  particularly  the  latter.     The  tax  of  Astoria, 
Oregon,  in  1906  was  only  $11  on  a  two-fifths  valuation.     This,  of 
course,  is  impossibly  low  for  a  growing  city  of  nearly  15,000  in- 
habitants.   A  little  inquiry  would  have  revealed  a  small  state  tax, 
a  $30  county  tax,  and  special  taxes,  making  a  grand  total  of  $58. 
In  this  instance,  as  in  many  others,  we  find  a  coextensive  school 
district  with  its  own  school  tax.    The  case  is  by  no  means  extreme. 
The  West  is  full  of  them.    And  yet,  as  often  as  not,  these  qualifying 
conditions   are   overlooked. 

532.  The  Tax  Power.  The  real  municipal  tax  rate  is  the  index 
of  the  extent  to  which  the  tax  power  is  being  employed  to  support 
and  acquit  current  and  fixed  charges.  The  extent  to  which  that 
tax  power  must  be,  and  the  extent  to  which  it  map  be  exercised 
are  the  most  important  considerations  in  purchasing  municipal 
bonds.  The  bondholder  (or  other  municipal  creditor,  such  as  city 
contractor,  or  water  company  which  has  rented  hydrant  privileges 
to  the  municipality)  ordinarily  has  only  the  powers  of  taxation 
to  fall  back  upon  in  case  of  breach  of  contract.  The  creditor, 
however,  has  recourse  to  the  full  power  of  general  taxation  other- 
wise appropriated  or  limited  by  law.1  General  taxation  includes 
the  tax  on  real  and  personal  property,  and,  when  there  are  such, 
the  poll  tax  and  the  business  tax. 

533.  But  the  creditor,  or  for  our  purposes,  the  bondholder,  must 
consider  to  what  extent  the  statutes  have  conferred  upon,  or  denied 
to,  the  municipality  the  general  powers  of  taxation;  for  the  courts 
are  powerless  to  grant  a  remedy  when  the  laws  fail  to  provide 

1  Holders  of  special  assessment  bonds  are  not  generally  so-  favored.     See  the 
next  chapter  under  Special  Assessment  Bonds. 


188      CITY  AND  TOWN  BONDS:  MUNICIPAL  ASSETS 

for  a  sufficient  levy,  or  when  they  restrict  it  to  such   an  extent 
as  to  make  it  insufficient. 

534.  Specific  Bond  Taxes.  It  is  to  prevent  mischances  of  this  sort, 
which  have  been  too  common,  that  fifteen  states  have  constitu- 
tional clauses  requiring  that  municipal  corporations  shall  not 
incur  indebtedness  without  passing,  at  the  same  time  or  previously, 
irrepealable  laws  or  ordinances  which  create  for  each  loan  a  tax 
Levy  and  collection  sufficient  to  pay  the  interest  and  retire  the 
principal  within  a  stated  period  of  years.  By  means  of  this 
specific  bond  tax  the  security  for  municipal  loans  is  greatly  en- 
hanced in 


California, 
Georgia, 
Idaho, 
Illinois, 


Iowa, 
Kentucky, 
Michigan, 
Missouri, 


New  Hampshire, 
North  Dakota, 
Oklahoma, 
Pennsylvania, 


South  Dakota, 

Texas, 

Wisconsin. 


Of  these  states  the  life  of  the  loan  is  limited  to  20  years  in  Illinois, 
Iowa,  Missouri,  New  Hampshire,  and  Wisconsin.  It  is  limited  to  25 
years  in  Oklahoma ;  to  30  years  in  Georgia  and  Pennsylvania ; 
to  40  years  in  Kentucky  and  California;  but  no  definite  period 
is  set  in  Michigan.  North  Dakota,  South  Dakota,  and  Texas,  al- 
though Texas  achieves  the  discharge  of  the  loan  in  much  the  same 
sort  of  way  by  requiring  an  annual  deposit  of  2  per  cent,  in  the 
sinking  fund. 

535.  There  are  not  a  few  respects  in  which  Canadian  finance, 
and  particularly  Canadian  municipal  finance,  is  in  advance  of  our 
own.  This  matter  of  special  tax  is  an  illustration.  In  Ontario  and 
all  of  the  provinces  west,  Manitoba,  Alberta,  Saskatchewan,  and 
British  Columbia, — but  not  in  Quebec, — it  is  required  that  for 
each  municipal  bond  issue  there  shall  be  a  specific  tax  levy  for  its 
support  and  ultimate  acquittal.  In  the  Maritime  Provinces,  New 
Brunswick,  Nova  Scotia,  and  Prince  Edward  Island,  a  special 
tax  levy  is  required,  and  also  a  special  act  of  legislature  to  legalize 
every  bond  issue. 

536.  In  those  states  which  do  not  protect  bondholders  by  special 
bond  taxes  a  substitute  for  the  constitutional  provision  is  often  had 
by  the  passage  of  a  municipal  ordinance  of  the  same  tenor,  which 
recites  that  "  there  shall  be  and  hereby  is  levied  a  direct  annual 
tax,"  etc.,  of  some  specified  amount  or  annual  percentage.  And 
even  in  those  states  wdiich  have  the  constitutional  provision,  mu- 


CITY  AND  TOWN  BONDS:  MUNICIPAL  ASSETS      189 

nicipalities  (e.g.  St.  Joseph,  Missouri,  recently)  will  sometimes  have 
their   loans   accepted   by   bond   houses   only   on   condition   that  a 
mandatory  ordinance  of  this  nature  be  passed;  for  attorneys  feel 
that  the  constitutional  provisions  have  not  as  yet  had  sufficient  in 
terpretation  by  the  higher  courts  to  be  relied  on  solely. 

537.  Although  only  fifteen  states  have  constitutional  provi- 
sions, perhaps  a  majority  of  the  bond-enabling  acts  passed  by  the 
various  legislatures  in  all  states  have  the  same  express  authority 
for  the  levy  of  taxes  to  meet  interest  and  maturing  principal ;  and 
bonds  issued  under  such  authority  offer  as  much  remedy  through 
the  courts  in  case  of  default  as  if  the  provision  was  in  the  state 
constitution  itself. 

538.  There  is  no  reason  why  the  same  end  may  not  be  attained 
in  municipal  charters,  and  occasionally  this  is  the  case.  The 
creditors  of  Yicksburg,  Mississippi,  have  the  satisfaction  of  know- 
ing that  the  city  is  required  by  its  charter  to  levy  taxes  to  meet 
the  interest  on  its  bonds  "  and  to  apply  any  surplus  of  the  sum 
so  raised,  after  payment  of  interest,  to  the  purchase  of  bonds  at 
or  below  par." 

539.  It  is  not  necessary,  however,  for  the  support  and  discharge 
of  a  debt,  that  specific  levies  be  raised  against  it  by  constitution, 
statute,  or  charter.  In  American  municipal  bond  law  the  implied 
power  of  taxation  is  a  principle  of  universal  application,  as  the 
federal  courts  have  invariably  held.  Indeed  it  is  only  an  exten- 
sion of  the  constitutional  principle  that  contracts  may  not  be  im- 
paired. And  even  when  loans  have  been  issued,  secured  by  pledge 
of  certain  definite  collateral,  such  as  stock,  and  no  reference  to,  or 
provision  for,  the  payment  of  the  loan  from  general  taxes  has  been 
made,  the  United  States  Supreme  Court  has  held  the  tax  resource 
valid  for  both  principal  and  interest,  and  has  issued  writs  of  man- 
damus to  compel  levy  and  collection.1 

540.  On  the  other  hand  the  courts  have  not  the  power  to  levy 
or  collect  taxes,  but  may  simply  issue  writs  for  the  performance  of 
these  duties,  and  coerce  the  proper  officials,  when  they  exist  and  are 
to  be  found.  For  this  purpose  the  political  organization  of  the 
larger  municipalities  renders  less  difficult  the  execution  of  the 
court's  order. 

541.  The  Tax  limitation.  But  the  power  of  taxation,  general  or 
special,  implied  or  specific,  cannot  be  invoked  by  the  bondholders 

1  For  the  application  of  this  principle  to  special  assessment  bonds,  see  The 
Bonds  of  Taxing  Districts,  under  the  caption  Special  Assessment  Bonds. 


190      CITY  AND  TOWN  BONDS:  MUNICIPAL  ASSETS 

when  its  application  will  conflict  with  ad  valorem  tax  limitations 
already  set  by  law.  These  limitations  have  already  been  discussed 
in  (heir  relation  to  state  and  county  debt.  Probably  only  three 
siaics  have  sweeping  constitutional  limitations'.  Kentucky,  Ala- 
bama, and  Oklahoma.  Kentucky  grades  her  tax  limitations  in  the 
same  general  way  that  we  have  found  her  debt  limitations  graded: — 
by  giving  greater  license  to  the  larger  municipalities.  The  maxi- 
mum tax  permit  led  cities  and  towns  having  a  population  of  15,000 
or  more  is  $15  a  thousand;  cities  and  towns  with  a  population  be- 
tween 10,000  and  15,000,  $10  a  thousand;  those  less  than  10,000, 
$7.50  a  thousand.  Counties  and  taxing  districts  are  limited  to  $5 
a  thousand,  except  that  counties  may  add  $2  for  public  roads. 
Alabama,  with  certain  exceptions,  makes  the  flat  rate  of  $5  a 
thousand  for  her  municipalities!  Oklahoma  restricts  the  state  to 
$3.50,  the  counties  to  $8  (with  exceptions  for  school  purposes),  the 
townships  to  $5;  cities  and  towns  to  $10;  and  school  districts  to 
$5.  By  the  constitution  of  1874  Arkansas  has  the  $5  limit  for 
her  counties.    Other  municipalities  in  the  state  are  not  limited. 

542.  A  few  states  have  statutory  limitations  that  serve  the  same 
purpose  and  are  much  more  to  be  feared  because  sometimes  more 
difficult  of  interpretation.  Ohio,  in  the  constitution  of  1851,  dele- 
gated this  power  to  the  legislature.  The  result  attained  is  the 
same.  The  taxpayers  are  given  a  crude  sort  of  protection  against 
burdensome  imports, — a  protection,  nevertheless,  which  is  unneces- 
sary with  proper  debt  restrictions,  and  is  prejudicial  to  the  credit 
of  a  state  and  its  municipalities.  How  tax  limitations  inure  to 
the  detriment  of  municipalities  is  best  illustrated  in  the  case  of 
Alabama.  Tinder  the  old  constitution  this  $5,  or  i  per  cent,  tax 
limitation  obtained,  as  at  present;  but  there  were  no  debt  restric- 
tions. The  city  of  Birmingham,  under  the  initial  impulse  of  a  new 
industrial  life,  which  has  since  made  it  famous,  felt  called  upon 
to  incur  debts  in  anticipation  of  an  increasing  power  to  pay,  and 
as  a  result  became  unable  to  ra\se  the  annual  tax  for  interest. 
To  relieve  the  situation,  an  amendment  to  the  old  constitution 
was  passed,  granting  Birmingham  an  increase  of  £  per  cent,  in  the 
tax  rate,  that  it  might  meet  the  interest  charges  and  make  some 
headway  toward  refunding. 

543.  In  view  of  this  and  other  similar  experiences,  the  Con- 
stitutional Convention  of  1001  supplemented  the  tax  limitation 
with  a  graded  debt  limitation.  At  this  time  the  city  of  Troy, 
Alabama,  was  in  default  of  interest  and  the  Constitution  of  1901 


CITY  AND  TOWN  BONDS:  MUNICIPAL  ASSETS      191 

authorized  an  additional  -J  per  cent,  to  the  tax  limitation,  subject 
to  the  vote  of  the  city.  "  This  provision,  however,  is  not  sufficient 
to  pay  the  interest"  said  the  Commercial  and  Financial  Chronicle. 
But  inasmuch  as  the  city  tax  rate  is  only  $5  a  thousand  upon  an 
assessed  valuation  that  has  since  run  from  $1,162,000,  to  f  1,240,000, 
and  the  total  bonded  debt  is  only  |144,500,  it  is  hard  to  see  why 
Troy  found  her  revenues  deficient.  At  any  rate  interest  has  been 
paid  of  recent  years. 

544.  Therefore  in  addition  to  the  legal  obstacles  which  a  tax 
limitation  raises  against  the  payment  of  debts,  it  encourages  a 
spirit  of  independence  in  the  taxpayers  that  in  the  long  run  is 
bound  to  be  reflected  in  the  credit  of  the  city  and  state.  Of  course 
this  is  the  unfortunate  fact  in  Alabama.1 

545.  It  must  be  borne  in  mind  that  restrictions  upon  the  tax 
rate  usually  cover,  not  only  moneys  raised  to  pay  the  interest  and 
principal  of  loans,  but  also  current  expenses.  In  municipalities 
proper,  expenses  are  comparatively  heavy,  and  therefore  the  risk 
of  the  bondholder  is  proportionately  increased;  for  the  munici- 
palities themselves,  and  not  the  courts,  are  the  arbiters  of  their 
own  domestic  economy;  and  when  they  choose  not  to  act  in  good 
faith  it  is  much  easier  for  them  than  for  quasi-municipal  corpora- 
tions to  swell  budgetary  appropriations,  to  the  impairment  of  their 
power,  within  the  law,  to  pay  their  debts  by  assessment.  San 
Francisco,  a  city  with  splendid  credit,  has  met  this  phase  of  tax 
limitation  in  an  excellent  and  unusual  way.  The  city  charter 
restricts  to  $10.70  the  tax  rate  for  current  expenses  and  main- 
tenance, but  leaves  unhampered  the  power  to  levy  for  the  support 
and  discharge  of  funded  debts. 

546.  Assessed  Valuation.  A  municipality  acting  in  bad  faith, 
especially  under  the  temptation  to  default  which  is  fostered  by 
material  calamities,  may  attain  the  same  result  under  a  law  restrict- 
ing the  power  of  taxation,  by  reducing  its  assessed  valuation  to  the 
point  where  the  tax  rate  is  little  more  than  sufficient  to  care  for 
current  expenses.  This  is  the  extreme  illustration  of  the  de- 
pendence of  the  tax  power  upon  wealth  which  it  may  tax. 

547.  Assessed  valuation,  or  assessment,  an  item  always  on  the 
bond  circular  under  the  city  statement,  is  not  hard  to  understand. 
It  is  the  value  put  upon  property  by  assessors  as  the  basis  for  tax- 

1  It  seems  incredible,  but  Massachusetts,  by  the  Acts  of  1910,  has  placed  a 
nominal  city  tax  limitation  of  $10.55  a  thousand.  The  limitation  is  no  hard- 
ship, but  at  this  late  day  seems  a  strange  departure  from  sound  fiscal  policy. 


192      CITY  AND  TOWN  BONDS:  MUNICIPAL  ASSETS 

ation.  The  "grand  list"  of  certain  states,  e.g.  Connecticut,  is  a 
synonym.  But  the  grand  list  of  Vermont  (1  per  cent,  of  the  real 
value)  is  quite  another  thing.  The  "tax  duplicate"  is  another 
synonym. 

548.  The  Basis  of  Assessed  Valuation.  Assessed  valuation  is  of 
importance  chiefly  in  its  relation  to  the  tax  rate  and  to  real  valua- 
tion. Real  valuation,  in  its  turn,  is  liable  to  different  interpreta- 
tions from  different  assessors.  Even  when  the  law  stipulates  the 
assessment  shall  be  at  full  value,  it  is  often  allowed  to  fall  far  short 
of  that.  Nominal  equivalents  are  "  true  valuation,"  "  fair  valua- 
tion," "  market  valuation,"  "  actual  valuation,"  "  real  valuation  in 
money,"  "  nominal  real  valuation,"  etc.,  etc.,  and  in  Iowa  "  ap- 
praised valuation"  (as  distinguished  from  "assessed  valuation."). 
This  lack  of  precision  in  terminology  is  itself  a  sign  of  different  in- 
terpretations. But  for  practical  purposes  real  valuation  is  an  in- 
variable common  denominator  sufficient  for  purposes  of  comparison; 
and  assessed  valuation  must  bear  some  definite  ratio  to  it.  The  re- 
lation of  assessed  valuation  to  debt  will  be  noticed  in  the  next  chap- 
ter under  the  topic  Debt  Limitations  and  Restrictions. 

549.  Comparison  of  Assessed  Valuations.  Since  assessed  valuation 
is  such  an  arbitrary  matter,  and  since  there  is  no  general  fixed  ratio 
of  assessed  to  real  valuation,  those  who  deal  with  statistics  should 
be  chary  of  comparisons  when  valuations  have  not  been  reduced  to 
the  common  denominator.  A  prominent  city  official  of  New  York 
sought  recently  to  reassure  business  men  in  regard  to  the  tremen- 
dous increase  in  the  metropolitan  debt  and  the  budgetary  appro- 
priations by  a  comparison  of  the  assessed  valuation  of  New  York 
with  that  of  other  communities.  "  When  the  Commissioner  pre- 
sented a  map  showing  that  the  assessed  values  in  the  entire  United 
States  west  of  the  Mississippi  River,  including  Minnesota  and 
Louisiana,  totaled  $5,249,072,325  against  the  total  assessed  valua- 
tion in  this  city  of  $7,158,190,000,  the  business  men  gasped." 

550.  Whether  the  comparison  was  qualified  or  not,  it  does  not 
gain  in  force  when  the  explanation  is  forthcoming  that  New  York 
is  assessed  at  nominal  full  value,  but  many  of  the  western  states 
at  not  more  than  one-third  value.  In  Nebraska,  under  the  general 
revenue  law  of  1903,  property  is  assessed  for  taxation  at  20  per 
cent,  only,  of  actual  value;  in  Iowa  the  rate  is  25  per  cent.,  and 
in  Kansas,  at  the  time  of  the  comparison,  about  33  per  cent,  (now 
full  value).  The  city  of  Pekin,  Illinois,  was  exceptional,  but  not 
isolated,  with  its  assessment  at  5  per  cent,  of  actual  value;  and 


CITY  AND  TOWN  BONDS:  MUNICIPAL  ASSETS      193 

Ellsworth,  Kansas,  at  10  per  cent.,  and  White  County,  Illinois,  at 
12£  per  cent. 

551.  In  general  it  should  be  remembered  that  the  North  Atlantic 
tier  of  states  is  committed  to  a  very  high  assessment  ratio,  and 
the  South  and  West  to  a  low  ratio.  Conversely,  of  course,  the 
average  tax  rate  in  the  North  Atlantic  tier  is  very  low,  and  in  the 
South  and  West  very  high.  The  chief  cause  of  both  facts  is  that 
the  great  burden  of  municipal  debt  is  being  borne  by  the  North 
Atlantic  tier.  Every  year  this  division  floats  more  municipal  loans 
than  all  the  rest  of  the  country  put  together.  The  real  valuation 
of  this  North  Atlantic  division  has  been  subject  to  less  fluctuation 
in  the  past  than  that  of  the  other  divisions;  and  it  has  been  able, 
with  greater  safety,  to  fix  its  tax  rate  upon  full  values.  But  the 
recent  financial  depression  has  made  us  realize  that  land  valua- 
tions in  the  West,  under  conditions  made  stable,  agriculturally,  by 
irrigation  (which  is  immediately  independent  of  rainfall),  and 
commercially,  by  growth  in  population,  are  prepared  for  a  full  as- 
sessment. 

552.  If  uniformity  of  accounting  is  desirable  for  railroad  and 
industrial  corporations,  it  is  desirable  for  municipal  corporations. 
Even  now,  when  a  city  in  the  West  is  hard  pressed  to  meet  annual 
charges  on  its  obligations,  under  customary  valuations  it  will,  at 
times,  tax  upon  full  valuation,  the  laws  permitting.  Thus  Keokuk, 
Iowa, — although  almost  every  other  municipality  in  the  state  taxes 
upon  a  25  per  cent,  valuation  basis. 

553.  Intercity  comparisons  of  assessed  valuation  are  not  so 
common  among  the  bond-buying  public  as  comparisons  of  assessed 
valuations  in  the  same  city  over  a  period  of  years.  The  principle 
need  hardly  be  touched  upon  again  that  this  sort  of  inquiry  must 
be  on  the  lookout  for  any  influences  which  may  have  changed  the 
basis  of  valuation.  Such  influences  may  be  economic,  as  in  the  case 
of  certain  Nevada  mining  towns  in  recent  years ;  but  they  are  more 
likely  to  be  bookkeeping  influences.  For  instance,  as  the  result 
of  an  amendment  to  the  Connecticut  statutes  in  1901  the  cor- 
poration stock  tax  was  made  collectable  by  the  state,  and  through 
the  state,  distributable  to  the  town  treasurers.  (The  same  thing 
occurred  in  Massachusetts  in  1864.)  So  the  assessed  valuations  of 
all  the  Connecticut  towns  are  depleted  to  that  extent,  since  1901. 
Hartford,  the  home  of  great  insurance  companies,  lost,  in  this 
new  adjustment,  two-thirds  of  her  personal  valuation.  On  the  other 
hand,  a  comparison  of  New  Haven's  valuation  at  that  time  would 


194       CITY  AND  TOWN  BONDS:  MUNICIPAL  ASSETS 

show  the  opposite  effect,  since  a  stronger  counteracting  agency 
was  at  work :  in  1900  New  Haven  changed  from  a  51  per  cent, 
to  a  full  valuation  basis. 

554.  The  Components  of  Assessed  Valuation.  Property,  for  pur- 
poses of  taxation,  is  subject  to  various  classifications,  the  main 
division  being  into  realty  and  personalty.  In  some  states,  railroad, 
express,  telegraph,  and  telephone  companies  make  returns  of  city 
property  directly  to  the  state,  to  the  detriment  of  the  city  state- 
ment. Stock,  banks,  and  franchises  are  at  times  inventoried  sep- 
arately, and  assessed  and  taxed  on  separate  bases.  Thus  realty  in 
Big  Kapids,  Michigan,  is,  or  used  to  be,  on  a  two-thirds  basis,  but  per- 
sonalty on  a  one-third  basis.  In  Roanoke,  Virginia,  there  is  no 
distinction  between  the  real  and  the  personal  assessment  basis, 
which  is  two-thirds,  but  the  corporal  ion  assessment,  a  distinct  in- 
ventory, is  on  a  three-quarters  basis,  and  bank  stock,  at  market 
value.  In  about  21  states  franchises  are  specifically  included  in 
the  general  property  tax.  It  has  been  mentioned  already  that  per- 
sonal property  sometimes  is  not  taxed  at  all — as  in  Wilmington, 
Delaware.  Figures  for  total  valuation  are  rendered  somewhat 
inaccurate  when  there  is  not  an  annual  revaluation  of  real  estate. 

555.  The  Relation  of  Realty  to  Personalty.  Just  as  the  rule  that 
a  low  tax  is  preferable  to  a  high  tax  has  so  many  exceptions  as 
to  discourage  its  application,  so  has  also  the  rule  that  the  Per- 
sonal component  of  Assessed  Valuation  should  be  a  high  percentage 
of  the  total.  It  is  only  by  repeated  application  to  towns  of  both 
good  and  poor  credit  that  it  becomes  safe  so  to  generalize.  It 
would  be  invidious  to  call  the  roster  of  cities  and  towns  taken 
as  examples  of  poor  credit;  but  an  examination  of  20  representative 
municipalities,  of  each  class  leads  to  the  conclusion  that  when 
personal  property  represents  one-third  or  more  of  the  real,  the 
credit  of  the  community  is  satisfactory,  and  its  tax  rate  per  thou- 
sand dollars  of  real  valuation  is  likely  to  be  low.  In  the  West  the 
personal  property  ratio  is  slightly  lower  for  the  same  grade  of 
credit.  The  town  of  Milton,  Massachusetts,  is  very  exceptional 
in  having  a  personal  valuation  slightly  greater  than  the  real,  and 
we  find  the  low  tax  rate  of  $11.50.  Brookline's  ratio  of  personal 
to  real  property  is  about  45  per  cent.,  with  a  tax  rate  of  $9. 

556.  On  the  other  hand  it  is  not  to  be  denied  that  personal 
property  is  getting  to  be  less  a  tax  resource  of  municipalities,  with 
the  gradual  change  of  method  in  imposts.  As  corporation  stocks, 
savings  bank  deposits,  mortgages,  and  local  municipal  bonds  dis- 


CITY  AND  TOWN  BONDS:  MUNICIPAL  ASSETS       195 

appear  from  the  assessment,  one  may  be  inclined  to  prefer  a  high 
rate  of  real  valuation.  A  large  part  of  this  personal  wealth,  how- 
ever, disappears  from  the  duplicate  onl}'  to  reappear  as  wealth  tax- 
able in  new  form.  Thus  the  shares  of  public  utility  corporations 
may  not  be  taxed  in  certain  states,  but  the  companies  themselves 
may  be  fully  taxed  by  the  state  direct,  through  their  franchises  or 
otherwise,  even  though  the  values  do  not  appear  on  the  municipal 
assessors'  books;  and  the  tax  may  be  prorated  among  the  interested 
municipalities.  A  reduction  in  the  amount  and  kinds  of  taxable 
personalty  has  sometimes  been  welcomed  by  real  estate  men,  e.g. 
in  Boston,  since  it  has  been  thought  to  attract  as  residents  men  of 
large  affairs. 

557.  Other  Resources;  Secondary  Income.  Having  disposed,  now, 
of  the  wealth  which  is  the  ordinary  resource  of  the  tax  power,  we 
come  to  those  other  material  assets  of  a  municipality  which,  though 
not  taxable,  contribute  to  its  financial  well-being.  For  convenience 
they  may  be  divided  into  assets  that  are,  and  assets  that  are  not, 
revenue-producing. 

558.  A  city  hall,  or  courthouse,  or  library,  usually  brings  the 
community  no  direct  return  on  the  investment;  though  it  may  be 
sub-let  in  part,  and  thus  become  productive.  But  in  so  far  as  mu- 
nicipal ownership  of  the  structure  saves  rentals  and  other  expendi- 
tures it  contributes,  of  course,  to  the  city's  net  income.  This  is 
to  be  remembered  in  connection  with  New  York  City's  tax-exempt 
municipal  property,  now  appraised  at  $9G4,309,185.1 

559.  The  very  presence  in  a  community  of  a  large  amount  of 
property_exempt  from  taxation,  whether  municipally  owned  or 
not,  attests  a  civic  intelligence  and  a  regard  for  institutions,  which 
inspire  high  public  credit,  even  if  they  do  not  minister  at  first 
hand  to  the  exchequer.  Of  such  property  are  churches,  hospitals, 
charitable  organizations,  etc.  Many  of  these  institutions  are  at 
no  great  remove  from  being  real  productive  assets.  College  and 
university  towns  would  be  more  fairly  rated,  commercially,  at  the 
value  of  all  property,  whether  exempt  or  not,  for  the  institutions 
bring  to  the  towns,  in  yearly  revenues  which  are  converted  into 
taxable  wealth,  several  times  the  interest  on  the  wealth  which  is 
not  taxed.  In  1905,  New  Haven,  Connecticut,  estimated  her  tax- 
exempt  property,  including  Yale  University,  at  $22,S22,470,  as 
compared    with     assessable    property,    $110,001,160.       Cambridge, 

1  1910.  Tax-exempt  property  in  private  and  private  corporation  ownership 
was  appraised  at  $322,365,754. 


196      CITY  AND  TOWN  BONDS:  MUNICIPAL  ASSETS 

Massachusetts,  has  no  accessible  list  of  tax-exempt  property  as  a 
whole,  but  the  exempt  real  estate  owned  by  Harvard  University 
was  appraised  in  1907  at  $7,378,000  on  an  assessed  valuation  for 
the  city  of  somewhat  less  than  New  Haven's.  "  It  is  worth  all  it 
costs,  and  more,"  says  the  President  of  the  Cambridge  Taxpayers' 
League,  "  to  have  Harvard  located  in  Cambridge."  Ithaca,  New 
York,  because  of  Cornell  University,  had  at  that  time  an  exempt 
valuation  of  $10,874,735,  which  is  even  greater  than  the  taxable 
valuation,  of  $7,219,440. 

560.  Among  possible  productive  assets  may  be  mentioned  treas- 
ury holdings  of  cash,  of  railroad  securities,  of  the  stocks  and  bonds 
of  local  water,  gas,  and  electric  companies,  and  the  city's  holdings 
of  less  readily  convertible  forms  of  wealth  such  as  delinquent  taxes, 
real  estate,  etc.  The  sinking  funds  are  important  assets  to  be 
considered  separately  in  connection  with  net  debt. 

561.  Cash  assets  of  the  larger  municipalities  are  often  of  much 
greater  value  than  most  people  realize.  On  January  8,  1907,  Phil- 
adelphia had  nearly  $18,000,000  in  cash  in  her  treasury,  apart  from 
sinking  funds  in  the  sum  of  $1,124,000.  This  $18,000,000  was  equal 
to  about  21  per  cent,  of  the  total  bonded  debt.  The  value  of  cash 
was  shown  by  the  Baltimore  fire.  In  1902  the  City  of  Baltimore 
sold  her  interest  in  the  Western  Maryland  Railroad  for  about 
$8,750,000,  and  approximately  half  the  sum  was  deposited  at  in- 
terest subject  to  30-day  draft.  After  the  fire  this  money  was  with- 
drawn to  meet  the  extraordinary  needs. 

562.  Another  notable  instance  of  proprietary  interest  in  rail- 
roads is  that  of  Cincinnati,  Ohio.  The  Cincinnati  Southern  Rail- 
road, owned  by  the  city,  is  leased  for  a  long  period  of  years  at  an 
average  annual  rental  (including  obligatory  charges  for  a  sinking 
fund)  practically  sufficient  to  pay  the  interest  on  the  city's  net 
funded  debt.  Fori  land,  Maine,  in  like  manner,  has  held  for  years 
a  sufficient  number  of  shares  of  the  Portland  and  Ogdensburg 
Railroad  (under  999-year  lease  to  the  Main  Central  at  2  per  cent, 
on  the  stock)  to  pay  two-fifths  of  its  interest  charges.  Most  of 
these  shares  have  now  been  sold  to  retire  the  funded  debt  as  it 
matured. 

563.  Sometimes  municipalities  acquire  the  securities  of  public 
service  corporations  for  purposes  of  municipal  ownership  or  con- 
trol, or  to  encourage  local  enterprises  that  benefit  the  community 
at  large.  These  acquisitions  may  or  may  not  appear  in  the  debt 
statement,  according  to  circumstances;  but  they  suggest  a  possible 


CITY  AND  TOWN  BONDS:  MUNICIPAL  ASSETS      197 

intimate  relation  between  secondary  assets  and  municipal  debt. 
In  the  nature  of  the  case  the  securities  owned  in  this  way  are 
usually  in  the  form  of  stock,  though  sometimes  in  bonds.  Louis- 
ville, Kentucky,  owns  (through  her  sinking  fund)  all  the  valuable 
stock  of  the  Louisville  Water  Company.  Frankfort,  Kentucky, 
owns  $32,000  6  per  cent,  bonds  of  the  Capital  Gas  and  Electric 
Company. 

564.  The  real  estate  owned  by  a  city  or  town  may  be  considered 
of  two  kinds,  not  only  in  its  relation  to  the  remedies  of  creditors 
in  case  of  default,  but  as  affecting  the  financial  competency  of 
the  city.  It  is  only  the  real  property  held  by  the  city  municipality 
in  its  proprietary,  rather  than  in  its  administrative  capacity,  that 
properly  comes  under  the  head  of  productive  assets.  In  1904  the 
value  of  the  salable  property  of  New  York  City  was  placed  at  over 
$686,000,000  by  the  United  States  Census  Bureau.  Of  this  amount 
about  $270,000,000  was  productive  property;  and  the  receipts  from 
it  were  $13,369,000,  or  about  12  per  cent,  of  the  revenues  from  all 
sources.  The  major  portion  of  this  $13,000,000  was  derived  from 
water  rates,  but  privileges  and  rentals  of  ferries,  docks,  wharves, 
and  landings  returned  $3,400,000.  The  metropolitan  subway  system, 
built  at  a  cost  of  about  $50,000,000,  has  added  since  that  time  to 
the  debt-paying  power  of  the  city,  both  immediately  and  potentially. 

565.  In  very  many  cities  and  towns  the  value  of  the  municipal 
property  is  greater  than  the  funded  debt, — often  several  times  as 
great.  In  Chicago  it  is  four  times,  and  in  Harrisburg,  Pennsyl- 
vania, twice.  But  the  ratio  of  the  two  figures  is  of  less  importance 
than  the  character  of  the  assets  and  obligations.  Colorado  Springs 
has  municipal  property  valued  at  more  than  twice  the  bonded  debt; 
but  80  per  cent,  of  the  property  and  90  per  cent,  of  the  debt  is  of 
the  best  kind,  representing  waterworks;  so  the  city  is,  to  some  in- 
tents and  purposes,  free  from  debt. 

566.  Waterworks.  The  amount  and  character  of  property  owned 
by  any  municipal  or  quasi-municipal  corporation,  especially  when 
in  the  less  settled  Southwest  and  Wrest,  and  especially  when  the 
population  is  a  matter  of  hundreds  or  scant  thousands,  have  an  im- 
portant bearing  upon  the  permanency  of  the  settlement.  Every 
statement  of  a  town  of  this  sort  in  Arizona,  New  Mexico,  Nevada, 
etc.,  should  be  analyzed.  Nothing  else  makes  for  stability  and  se- 
curity like  good  waterworks,  operated  and  owned  by  the  municipal 
corporation.  Undoubtedly  the  large  majority  of  these  through- 
out the  country  are  self-supporting;  and  some  of  them  earn  a  suffi- 


19S      CITY  AND  TOWN  BONDS:  MUNICIPAL  ASSETS 

cient  amount,  not  only  to  pay  the  interest  and  principal  of  the 
water-debt,  but  of  all  oilier  bonded  debts  besides.  This  is  the 
case  in  Augusta,  Georgia.  Although  the  city's  debt  exceeds  present 
constitutional  limitations,  the  city  is  nearly  as  competent,  finan- 
cially, as  if  without  debt.  The  waterworks  of  Port  Iluron,  Michi- 
gan, earned  for  the  year  1907,  over  all  operating  expenses,  an 
amount  sufficient  to  pay  71  per  cent,  of  the  interest  on  all  the  city's 
indebtedness. 

567.  Municipal  water  bonds  as  a  class  are  a  premier  security  be- 
cause of  the  ease  and  certainty  of  their  support  and  ultimate  pay- 
ment. In  municipal  bankruptcy  they  have  generally  fared  better 
than  the  other  funded  obligations  (e.g.  Rahway,  New  Jersey).  By 
city  charter  or  otherwise  it  is  commonly  stipulated  that  they  are  not 
a  primary  charge  on  taxable  property,  but  on  the  use  of  the  water 
itself;  so  it  usually  is  given  to  the  board  of  Water  Commissioners, 
or  some  similar  body,  to  establish  such  water  rates  as  will  at  all 
times  insure  to  the  city  a  sufficient  income  to  pay  the  interest  and 
to  provide  a  fund  to  pay  the  principal  of  all  bonds  issued  for 
water  purposes. 

568.  It  may  seem  at  first  that  water  loans,  which  do  not  have 
for  maintenance  and  payment  an  express  resort  to  the  general 
power  of  taxation,  must  suffer  in  security;  but  this  is  not  neces- 
sarily the  case.  Subject  of  course  to  tax  limitations  the  doctrine 
of  the  implied  powTer  of  taxation  which  is  inherent  in  every  bond 
enabling  act  that  creates  a  direct  obligation  of  a  civil  corporation, 
gives  the  holder  of  water  bonds  the  same  protection  through  the 
tax  levy  as  if  the  bonds  did  not  have  their  own  special  means  of 
amortization.  But  wrhen  water  bonds,  or  any  other  bonds,  are  pay- 
able from  the  income  of  designated  property,  and  are  liable,  on 
failure  of  this  resource,  to  encounter  limitations  of  the  tax  power, 
they  are  better  let  alone.  We  cannot  cite  a  failure  of  water  bonds 
in  illustration  of  this  point.  The  interest  on  Selma,  Alabama, 
Building  4s  faces  this  predicament.  The  interest  is  met  from  the 
rentals  of  the  market  constructed  with  the  proceeds  of  the  bonds; 
but  market  rentals  of  themselves  are  an  insufficient  security;  and 
Alabama  municipals  are  the  worst  possible  paper  to  leave  to  the 
mercies  of  an  abridged  tax  power. 

569.  Considering  the  absolute  necessity  of  an  adequate  water 
supply  in  thickly  settled  communities,  and  the  customary  financial 
provisions,  it  becomes  evident  that  water  bonds  are  the  most 
desirable  class  of  municipals,  and   that  in  municipal  accounting 


CITY  AND  TOWN  BONDS:  MUNICIPAL  ASSETS      199 

legislatures  are  justified  in  permitting  water  loans  to  be  subtracted 
from  gross  debt,  in  computations  of  net  debt. 

570.  The  bond  buyer,  however,  should  be  extremely  careful  in  pur- 
chasing water  bonds  to  note  whether  he  is  receiving  bona  fide  direct 
municipal  obligations.  If  memory  is  to  be  trusted,  investors  and 
even  bond  houses  have  carelessly  picked  up,  in  the  course  of  trade, 
Raleigh,  North  Carolina,  Water  6s,  and  Rockland,  Maine,  Water  5s, 
only  to  find  they  held  public  utility  securities.  The  public  attitude 
toward  the  two  kinds  of  water  loans  may  be  shown  by  an  instance. 
In  1904,  Topeka,  Kansas,  bought  the  local  waterworks  from  the 
Topeka  Water  Company  for  f350,000  in  4  per  cent.  Water  Works 
Purchase  Bonds,  and  at  the  same  time  assumed  the  $270,500  5  per 
cent,  bonds  of  the  Water  Company.  At  this  writing  the  differ- 
ence in  the  selling  price  of  these  two  issues  is  equivalent  to  f  per 
cent,  income,  annually,  in  favor  of  the  direct  municipal  obligation. 

571.  Prior  Lien  and  Mortgage  Security.  Hitherto,  in  this  chapter, 
we  have  dealt  with  the  security  for  municipal  bonds  as  dependent, 
directly  or  indirectly,  upon  the  power  of  taxation  and  the  re- 
sources of  the  tax  power.  It  is  the  tax  power,  as  distinguished 
from  earning  power  and  mortgage  lien,  which  mainly  differentiates 
the  security  of  municipal  bonds  from  corporation  bonds.  And  yet 
even  municipal  obligations  sometimes  have  varying  degrees  of 
priority;  and  not  a  few  are  secured  by  mortgage. 

572.  The  bonds  of  the  old  city  of  Brooklyn,  under  the  terms  of 
the  consolidation  with  New  York,  must  first  be  satisfied,  principal 
and  interest,  from  the  proceeds  of  taxes  upon  Brooklyn  Borough 
property,  before  the  bonds  issued  by  the  Greater  New  York  shall  be 
provided  for,  from  these  same  moneys. 

573.  Maine,  Massachusetts,  and  Connecticut,  and  doubtless  the 
other  New  England  states,  offer  what  is  virtually  mortgage  se- 
curity, as  well  as  that  furnished  by  the  tax-power,  for  their  mu- 
nicipal obligations. 

"  In  the  New  England  States  judgments  against  municipalities  are  not  enforced 
by  mandamus,  but  in  a  mode  peculiar  to  those  states.  By  the  common  law  of 
the  New  England  States,  derived  from  immemorial  usage,  the  estate  of  an  in- 
habitant of  a  county,  town,  territorial  parish,  or  school  district,  is  liable  to  be 
taken  on  execution  on  a  judgment  against  the  corporation."  1 

The  importance  of  this  resource  of  execution  to  owners  of  New 
England   municipal   bonds   can   hardly  be  overestimated.   It  puts 

1  Dillon,   Municipal  Corporations,  4th  ed.,  Note  to  §  849,  p.   1027. 


200      CITY  AND  TOWN  BONDS:  MUNICIPAL  ASSETS 

New  England  obligations  quite  apart,  in  a  class  by  themselves,  dis- 
tinct and  superior  to  all  other  classes  of  corporate  loans. 

574.  By  the  New  Jersey  laws  of  1903,  school  district  bonds 
issued  under  the  terms  of  the  School  Act  are  secured  by  lien  on 
all  the  real  estate  and  personal  estates  of  the  district  issuing 
them. 

575.  We  know  of  no  circumstances  other  than  these  under 
which  any  class  of  municipal  bonds  enjoys  what  is  virtually  mort- 
gage security;  but  special  assessment  bonds  are  not  uncommonly 
secured  by  lien  on  the  improved  property,  notably  in  Illinois,  and 
in  a  few  states  the  private  property  of  municipal  corporations, 
held  for  profit  and  charged  with  no  public  trusts,  may  be  sold  on 
execution. 

576.  The  instances,  however,  in  which  individual  issues  of  mu- 
nicipal bonds  are  secured  by  mortgage  liens  are  more  numerous 
than  most  people  suppose.  They  generally  arise  from  the  express 
sanction  of  legislatures,  when  some  productive  property  or  plant 
is  purchased  or  constructed  by  money  raised  on  the  bonds.  It  may 
happen  that  the  security  of  simple  debentures  is  considered  in- 
sufficient. This  accounts  in  part  for  the  fact  that  irrigation  dis- 
trict bonds  are  so  generally  a  lien  prior  to  other  municipal  issues 
subsequently  imposed;  and  this  accounts  in  whole  for  the  Mobile 
Funding  bonds  of  1882,  the  outcome  of  Mobile's  compromise  of  that 
year.  The  bonds  represent  a  purchase  mone}'  mortgage  given  for 
some  wharf  propert}'.  The  rentals  from  the  property  are  of  them- 
selves insufficient  for  the  support  and  early  retirement  of  the  issue, 
and  therefore  the  legislature  has  created  a  special  tax  of  f  per 
cent,  of  this  city's  taxable  property  toward  the  same  end.  Some 
of  the  municipalities  of  Tennessee,  notably  Memphis,  have  been 
enabled  to  acquire  public  market  houses  by  mortgaging  the 
market  property.  Memphis  has  mortgaged  her  parks  also;  and  her 
School  Bonds  of  1937  are  secured  by  a  mortgage  covering  all  the 
real  estate  and  buildings  owned  by  the  school  board. 

577.  Since  waterworks  offer  property  tangible  for  seizure,  and 
the  most  certain,  stable,  and  generous  income  to  support  obliga- 
tions created  against  them,  it  is  water  bonds  that  are  most  com- 
monly secured  by  mortgage  liens  and  the  pledge  of  revenue.  Many 
municipalities  in  Georgia,  Alabama,  and  Iowa  have  profited  by 
these  conditions  to  secure  their  water  bonds  under  mortgage. 
North  Birmingham,  Alabama,  has  both  Water  and  Light  Bonds 
secured  by  mortgage.    Columbia,  South  Carolina,  has  a  small  issue 


CITY  AND  TOWN  BONDS:  MUNICIPAL  ASSETS      201 

of  mortgage  water  bonds  and  a  larger  issue  of  plain  water  deben- 
tures. Duluth  has  a  large  and  well-known  issue  of  Water  and  Light 
4s  which  are  a  lien  on  the  title  of  the  city  to  the  plant.  And  Louis- 
ville, Kentucky,  has  recently  issued  some  second  mortgage  bonds  on 
the  Louisville  Water  Company. 

578.  The  fact  that  these  mortgage  loans  are  municipal  does  not 
absolve  them  from  usual  foreclosure  proceedings  in  default  of 
interest.  It  will  be  remembered  that  one  possible  advantage  in 
the  issues  of  private  corporations  is  that  the  principal  matures  on 
default  of  the  interest.  With  unsecured  municipal  issues,  however, 
action  cannot  be  taken  to  secure  the  principal,  but  only  the  de- 
faulted interest;  and  it  requires  the  ownership  of  a  large  amount 
of  bonds  to  make  it  worth  while  for  any  holder  to  proceed  at  law 
to  realize  upon  his  coupons,  especially  in  the  federal  courts,  which, 
of  course,  are  not  open  to  a  joint  action,  or  to  an  action  involving 
less  than  $2,000.  In  the  case  of  defaulted  mortgage  bonds,  however, 
there  is  recourse  upon  the  principal,  and  the  ordinary  procedure 
of  equity  will  govern,  except  that  in  the  case  of  mortgage  water 
bonds,  the  courts,  under  necessity  of  preserving  the  public  wel- 
fare, may  be  reluctant  to  appoint  a  receiver. 

579.  There  is  another  sense  in  which  municipal  bonds  are  some- 
times associated  with  prior  lien  security,  by  the  layman.  He  is, 
perhaps,  told  by  the  enthusiastic  writers  of  bond  circulars  that 
since  municipal  bonds  are  "  secured  "  by  the  power  of  taxation, 
and  taxes  come  ahead  of  all  other  claims  on  property,  therefore  all 
the  taxable  property  may  be  sold  for  taxes  to  pay  the  bonds, — 
which  means  that  the  bonds  are,  in  effect,  a  first  lien  on  all  the  tax- 
able property  in  the  community,  and  as  such  come  ahead  of  all 
first  mortgages  on  real  estate,  and  ahead  of  all  first  mortgage 
bonds  of  any  railroad  or  other  corporation  in  the  community.1 

580.  If,  in  any  true  sense,  New  York  City  bonds  "  came  ahead  " 
of  first  mortgages  on  New  Yrork  real  estate,  the  bonds  would  not  be 
selling  on  a  4.05  per  cent,  basis  at  this  time  when  the  best  mortgages 
sell  on  a  3.50  basis,  for  the  only  respect  in  which  the  mortgages 
can  be  better  than  the  bonds  is  the  security. 

581.  All  the  taxable  property  of  a  community  may  not  be  sold 
for  the  bonds.  A  theory  is  worth  nothing  unless  it  is  approximated 
in  practice.  Outside  of  New  England  municipal  bankruptcy  and 
default  do  not  even  suggest  foreclosure  proceedings.     Apart  from 

1  Quoted  almost  verbatim  from  a  recent  municipal  bond  circular  of  an  active 
young  Western  bouse. 


202      CITY  AND   TOWN   RONDS:   MCN1CIPAL  ASSETS 

the  exceptions  already  mentioned  there  is  nothing  behind  munici- 
pal bonds  analogous  to  the  real  estate  mortgage. 

582.  Population.  In  treating  state  credit  the  matter  of  popula- 
tion was  touched  upon  in  the  light  of  an  indirect  material  asset. 
The  figures  for  population  generally  appear  on  a  bond  offering, 
and  they  are  of  no  inconsiderable  weight  with  the  bond  buyer. 
Two  numbers  are  usually  given:  those  of  the  last  federal  or  state 
census,  and  the  present  estimate.  Since  the  national  census  is 
taken  only  once  in  ten  years  and  the  majority  of  states  do  not 
supplement  it,  there  is  real  necessity,  in  a  growing  country  like 
ours,  that  more  approximate  returns  be  had.  A  state  census  helps 
to  bridge  the  chasm  in 

Rhode  Island,  Florida,  Minnesota.  Kansas, 

Massachusetts,  Michigan,  North  Dakota,  Iowa, 

New  York,  Wisconsin,  South  Dakota,  Wyoming. 
New  Jersey, 

In  addition,  here  and  there,  a  local  census  may  be  authorized  by 
the  state  for  this  or  that  purpose. 

583.  It  is  the  natural  tendency  to  be  skeptical  of  estimates, 
especially  when  on  mushroom  towns  of  newly-developed  sections  in 
the  South  and  West.  That  estimates  of  population  are  given  in 
round  numbers  does  not  militate  against  their  accuracy.  They 
are  usually  based  on  school  and  directory  returns,  and  assuming 
that  they  are  compiled  in  good  faith,  are  accurate  enough  for  the 
purpose.  A  study  of  these  estimates  in  a  large  number  of  cases 
leads  to  the  conclusion  that  gains  in  population  are  usually  com- 
puted at  no  greater  rate  than  the  ascertained  rate  of  gain  for  the 
preceding  census  period.  On  the  Pacific  Coast,  where  the  craze 
for  material  growth  is  greatest,  estimates  of  population  are  over- 
sanguine  and  sometimes  the  census  returns  are  even  fraudulent. 

584.  The  rule  for  population  is  very  simple: — the  larger  the 
better.  And  the  reasons  thereof  have  been  canvassed  in  the  pre- 
ceding chapter.  In  addition  to  what  was  stated  there  it  may  be 
remarked  that  75,000  is  approximately  the  turning  point  in  a  city's 
growth.  At  that  size  the  town  begins  to  take  on  metropolitan 
characteristics.  Its  places  of  amusement  multiply,  its  mercantile 
life  overflows  the  main  thoroughfare;  it  is  awake  by  night  as  well 
as  by  day;  it  becomes  a  shopping  center;  traction,  lighting,  and 
other  public  utilities  are  placed  on  a  commercial  basis;  its  realty 
valuations  and  the  growth  in  valuations  are  more  secure;  habits 


CITY  AND  TOWN  BONDS:  MUNICIPAL  ASSETS      203 

of  thought  and  business  and  social  proceeding  lose  their  insularity, 
and  tend  toward  cosmopolitanism.  From  the  standpoint  of  the 
city's  obligations,  no  one  will  question  the  desirability  of  all  these 
changes. 

585.  Change  in  population  is  usually  indicated  on  the  circular  by 
the  difference  between  the  Census  and  the  "  present  estimated " 
figures.  In  the  United  States  the  change  is  quite  generally  growth, 
irrespective  of  the  kind  of  municipality,  unless  the  municipality 
has  lost  territory  by  partition,  or  other  reapportionment  of  bound- 
aries. Annexation,  however,  has  been  so  prevalent  of  recent  years, 
that  statistics  of  growth  may  at  times  mislead.  No  informed  per- 
son will  be  misled  by  New  York  or  Chicago,  but  one  is  so  used 
to  tremendous  gains  in  the  West  that  this  explanation  for  part  of 
the  gains,  as  in  Salem,  Oregon,  or  Los  Angeles,  California,  is  likely 
to  be  overlooked. 

586.  In  this  country  a  stationary  or  receding  population  is  not 
to  be  met  with  favor.  Except  under  extraordinary  conditions,  such 
as  fire,  flood,  or  earthquake,  losses  in  population  are  in  the  smaller 
communities;  and  they  are  accompanied  with  other  signs  of  dis- 
tress, such  as  a  high  tax  rate.  Witness  Merrimac,  Massachusetts. 
The  75,000  mark  of  safety  will  generally  exclude  bonanza  towns,  one- 
industry  towns,  and  pleasure  resorts,  which  are  more  liable  to 
vicissitudes  than  most  municipalities. 

587.  Per  capita  studies  in  population  are  not  very  satisfactory. 
It  has  been  found,  strangely  enough,  that  the  strength  of  govern- 
ments and  their  securities  tends  to  vary  as  the  per  capita  debt; 
and  the  same  is  true,  for  at  least  the  larger  cities  of  this  country. 
Still  it  does  not  follow  that  strength  and  debt  stand  in  any  relation 
of  cause  and  effect.  Perhaps  the  relation  of  population  to  debt 
is  best  studied  through  the  medium  of  wealth  or  real  valuation. 
The  relation  of  population  to  valuation  has  more  significance.  The 
real  valuation  per  capita  is  greatest  in  wealthy  residential  communi- 
ties,—which  offer  high  credit.  It  will  run  from  $2,000  to  $4,000  per 
inhabitant.  This  is  due  in  part  to  the  comparatively  high  ratio 
of  personal  to  real  property  valuations  in  these  communities.  In 
manufacturing  cities  it  will  run  as  low  as  $500.  As  in  the  matter 
of  tax  rates,  villages  will  run  to  greater  extremes  both  ways. 

588.  Population  has  its  qualitative,  as  well  as  its  quantitative, 
aspects.  They  have  been  referred  to  in  previous  pages.  The  per- 
sonal equation,  individually  or  collectively,  has  a  great  effect  on 
credit.     Since,  however,  there  is  no  unanimity  of  opinion  and  no 


204      CITY  AND  TOWN  BONDS:  MUNICIPAL  ASSETS 

profitable  appeal,  except  to  the  moral  of  past  default  and  repudia- 
tion, the  subject  is  not  discussed  further. 

589.  These  then,  in  tine,  are  the  material  aspects  of  bond  security 
the  buyer  must  scan:  the  tax  resource  in  its  scope  and  limitations, 
and  its  basis  in  assessed  and  real  valuations;  the  secondary  re- 
sources of  cash  and  collateral ;  priority  of  obligation  in  the  bond, 
and  mortgage  lien;  and  lastly,  population. 


CHAPTER  XVII 
CITY  AND  TOWN  BONDS:  MUNICIPAL  LIABILITIES 

590.  Municipal  Debt.  On  the  other  side  of  the  balance  sheet,  over 
against  valuation,  is  municipal  debt.  The  census  bureau  finds  that 
in  1906  the  revenues  of  national,  state,  territorial,  and  county 
governments  exceeded  expenditures,  i.e.  their  net  indebtedness  de- 
creased; but  the  indebtedness  of  cities,  towns,  and  minor  civil  divi- 
sions increased.  The  increase,  strange  to  say,  meets  with  least  hin- 
drance in  the  conservative  Northeast;  and  the  two  leading  cities  of 
this  section,  New  York  and  Boston,  are  the  worst  offenders,  at  least 
statistically  speaking,  with  the  highest  per  capita  net  debt  in  the 
country. 

591.  Municipal  debt  is  often  a  very  complex  thing; — unneces- 
sarily so;  and  there  is  as  much  difference  of  opinion  as  to  what 
constitutes  debt,  and  net  debt,  among  the  authorizers  of  municipal 
debts,  the  legislatures,  as  in  other  financial  matters.  There  is  the 
debt  proper,  the  General  Debt,  more  or  less  permanent  in  character, 
about  which  there  is  less  chance  of  disagreement,  unless  the  legality 
of  some  issue  should  be  in  dispute.  There  are  also,  perhaps, 
various  forms  of  temporary  or  floating  debt,  which  should  or  should 
not  be  included  in  the  debt  statement,  according  to  the  statutory  or 
judicial  interpretation  of  debt.  They  are  generally  issued  only 
against  perfect  assets,  like  unmatured  or  unpaid  taxes,  unpaid 
assessments,  etc.  Of  this  class  are  Revenue  Bonds,  Temporary 
Loan  Bonds,  Tax  Relief  Bonds,  and  Deficiency  Bonds,  although  all 
kinds  are  often  merely  notes,  informally  drawn,  and  not  under  seal, 
which,  to  defray  current  expenses,  have  been  issued  in  anticipation 
of  the  year's  taxes,  from  which  they  will  be  redeemed.  Warrants, 
which  have  the  main  characteristics  of  the  bonds  mentioned  above, 
may  be  defined  as  temporary  certificates  of  debt  issued  in  default 
of  cash  to  casual  creditors  of  a  municipality  or  state,  payable, 
principal  and  interest,  like  Revenue  Bonds,  from  outstanding  taxes, 
excess  water  rents,  or  any  other  surplus  revenues.  They  are  gen- 
erally included  in  the  total  debt. 

592.  Floating  Debt,  carried  over  from  year  to  year,  has  no  in- 

205 


206    CITY  AND  TOWN  BONDS:  MUNICirAL  LIABILITIES 

herent  advantages  to  recommend  it.  The  excellent  laws  of  Cali- 
fornia prohibit  it  in  thai  state.  To  encourage  the  discharge  of 
floating  debt  some  states  do  not  permit  the  funding  of  it  until  it 
reaches  a  certain  sum,  e.g.  $25,000.  Floating  debt  is  almost  in- 
variably included  with  funded  debt  in  debt  restrictions.  What- 
ever may  be  the  local  attitude  toward  the  interpretation  of  debt 
limitations,  and  net  debt,  a  thorough-going  accountancy  will  re- 
quire the  amount  of  floating  debt.  Leadville,  Colorado,  is  an  ex- 
ceptional case,  but  for  years  the  city  has  had  a  floating  debt  in 
excess  of  $200,000,  or  10  per  cent,  of  the  assessment.  On  the  other 
hand,  when  the  floating  debt  represents  merely  the  year's  accumu- 
lations of  debits,  to  be  discharged  out  of  the  year's  revenues,  it 
may  fairly  be  discounted;  for  presumably  it  is  offset  by  propor- 
tionate growth  in  wealth,  which,  in  turn,  has  not  yet  been  tabulated 
in  the  town's  assessed  valuation.  New  York  City  sometimes  has 
outstanding  in  the  form  of  revenue  bonds  a  floating  debt  to  the 
amount  of  many  millions. 

593.  Under  General  Debt  are  likely  to  be  found  accidental  items. 
Unfunded  liabilities  for  contracts,  and  for  land  purchases,  are 
important  in  large  cities  which  are  being  extensively  developed  and 
improved.  In  1908  the  amount  charged  to  these  purposes  in  New 
York  was  $53,000,000.  Less  important  in  number  and  amount  are 
judgment  debts:  obligations  made  legal  by  court  decisions;  and 
unretired  certificates:  bonds  and  coupons  that  have  matured  but 
have  not  been  presented  for  payment.  Philadelphia  had  $80,000  of 
the  latter  outstanding  in  1907.  Occasionally,  but  not  as  often  as 
in  state  debts,  we  find  loans,  generally  irreducible,  or  perpetual, 
that  are  the  result  of  endowments  or  charitable  bequests,  as  in 
Lowell,  Massachusetts.  When  they  are  taken  into  the  sinking 
funds  or  otherwise  absorbed,  the  interest  becomes  a  bookkeeping 
charge,  and  the  principal  is  included  in  the  General  Debt;  but 
when  the  funds  are  set  apart  in  trust,  and  there  is  no  charge  on  the 
city  for  maintenance,  they  may  properly  appear,  like  water  loans, 
distinct  from  the  general  debt.  Leominster  and  Medford,  Massa- 
chusetts, in  this  way  have  funds  included  in,  and  Medford  has 
funds  excluded  from,  the  general  debt  statement. 

594.  Contingent  Debt.  Trust  funds  that  may  properly  be  ex- 
cluded from  the  general  debt  are  in  the  last  analysis  always  Contin- 
gent Debt.  Contingent  Debt  takes  many  other  forms  as  well.  Woon- 
socket,  Rhode  Island,  and  many  other  municipal  corporations,  in 
New  England  and  out,  East  and  West,  North  and  South,  indorse 


CITY  AND  TOWN  BONDS:  MUNICIPAL  LIABILITIES     207 

or  guarantee  the  bonds  of  local  railroads.  Most  of  these  obliga- 
tions, especially  in  the  West  and  South,  are  an  unfortunate  heri- 
tage of  the  seventies  and  eighties,  when  the  people  of  this  country 
played  fast  and  loose  with  their  corporate  credit.  These  indorsed 
bonds,  however,  are  to  be  distinguished  from  railroad  aid  bonds. 
Columbia,  South  Carolina,  guarantees  the  interest,  but  not  the 
principal,  on  |200,000  Canal  bonds.  Many  cities  guarantee  the 
water  bonds  of  water  companies  they  have  purchased.  Austin, 
Minnesota,  guarantees  and  pays  the  interest  on  moneys  loaned  the 
Southern  Minnesota  Normal  College.  As  to  whether  special  assess- 
ment bonds  are  a  contingent  obligation  of  a  corporate  body  de- 
pends in  part  on  the  court  having  jurisdiction.  If,  as  in  Kansas, 
an  assessment  bondholder  has  recourse  on  the  municipality  as  a 
whole,  in  default  of  the  special  tax  on  the  property  immediately 
benefited,  then  the  bonds  are  a  contingent  liability.  At  least  in 
cities  of  the  first  class,  in  Kansas,  they  are  direct  obligations. 
Otherwise,  and  more  generally,  as  in  Indiana  under  the  Barrett 
Law,  they  are  not  a  contingent  liability. 

595.  The  laws  and  practices  of  the  several  states  vary  so  greatly 
that  it  is  impossible  to  lay  down  any  fast  rule  as  to  what  forms 
of  Contingent  Debt  shall  be  accredited  to  General  Debt  account. 
This  much  at  least  may  be  said :  when  the  burden  of  the  support 
and  discharge  of  the  debt  falls  directly  on  the  municipality  as  a 
whole,  a  proper  accounting  will  attribute  the  fund  to  General  Debt; 
when  it  falls  upon  the  municipality  only  indirectly,  by  default,  or 
when  it  falls  directly  upon  only  a  part,  the  item  is  outside  of 
the  General  Debt,  but  embraced  in  the  Total  or  Gross  Debt,  when 
the  General  and  Total  Debts  are  distinguished. 

596.  The  Real  Debt  of  Cities  and  Towns.  The  distinction  between 
the  nominal  debt  of  the  political  division  called  county  and  the 
real  debt  which  has  to  be  borne  by  the  county  community  was  dis- 
cussed at  length  in  the  preceding  chapter.  This  distinction  is  not 
so  important  for  cities,  towns,  and  villages  as  a  class.  But  never- 
theless there  are  hundreds,  if  not  thousands,  of  municipal  cor- 
porations that  exhibit  similarly  misleading  debt  statements. 

Many  municipalities  have  taxing  districts  (such  as  form  the  sub- 
ject of  a  succeeding  chapter)  that  are  actually  or  practically  co- 
extensive with  the  cities  or  towns.  The  two  commonest  forms 
are  school  districts,  and  fire  or  water  districts.  These  quasi- 
municipal  corporations  often  issue  their  loans  in  such  amount  as 
to  double  the  burden  of  funded  debt  that  has  to  be  supported  by 


208    CITY  AND  TOWN  BONDS:  MUNICIPAL  LIABILITIES 

the  taxpayers.  The  burden  will  appear  in  the  two  tax  rates,  which 
are  based  on  actual  property  values;  but  it  will  not  appear  in  the 
debt  statement  of  the  city  or  town  alone.  Therefore  it  behooves 
the  bond  buyer,  who  seeks  actual  conditions,  to  learn  whether 
taxing  districts,  by  a  separate  accounting,  are  concealing  the  lia- 
bilities that  are  a  charge  upon  the  community  in  question.  Of 
course  the  bond  issues  of  the  minor  quasi-corporation  have  no 
bearing  upon  the  debt  limitation  of  the  major  corporation,  or  upon 
questions  of  legality  that  issue  therefrom. 

597.  Chicago  furnishes  the  illustration  par  excellence  of  a  city 
administered  and  financed  by  districts,  or  subsidiary  corporations, 
each  with  its  separate  funded  loans.  But  by  recent  constitutional 
amendment,  the  legal  net  debt  of  Chicago  is  interpreted  as  com- 
prising, not  only  the  present  city  debt  proper,  but  the  debt  of  all 
municipal  corporations  lying  wholly  in  the  city,  and  the  city's 
portion  of  the  debt  of  the  county  and  sanitary  district.  This  is  the 
only  important  legislative  recognition  that  comes  to  mind,  of  the 
true  nature  of  municipal  debt. 

598.  There  is  one  constitutional  recognition,  however,  that  is 
even  more  satisfactory,  since  it  applies  the  same  principle  to  all 
municipalities  in  the  state.1  The  debt  limit  in  South  Carolina  is 
8  per  cent,  for  every  political  subdivision.  But  the  debts  and  tax 
burdens  are  not  allowed  to  overlap  without  stint,  for  "  wherever 
there  shall  be  several  political  divisions,  or  municipal  corporations 
covering  or  extending  over  the  territory  or  portions  thereof,  pos- 
sessing a  power  to  levy  a  tax  or  contract  a  debt,  then  each  of  such 
political  divisions,  or  municipal  corporations  shall  so  exercise  its 
power  to  increase  its  debt  under  the  foregoing  8  per  cent,  limita- 
tion that  the  aggregate  debt  over  and  upon  any  territory  of  this 
state  shall  never  exceed  15  per  cent,  of  the  value  of  all  taxable 
property  in  such  territory  as  valued  for  taxation  by  the  state. 
Provided  that  nothing  herein  shall  prevent  the  issue  of  bonds  for 
the  purpose  of  paying  or  refunding  any  valid  municipal  debt  here- 
tofore contracted  in  excess  of  8  per  cent." 

599.  There  is  adequate  recognition  of  true  debt  in  the  admirable 
rules  governing  the  investment  of  trust  funds  of  Baltimore.  These 
funds  may  be  invested  in  the  bonds  of  municipalities  the  net  in- 
debtedness of  which  "  together  with  the  indebtedness  of  any  Dis- 
trict,  or   other   Municipal   corporation,   or   subdivision,  except   a 

1  The  principle  is  recognized  with  less  definitenesa  in  the  constitution  of  South 
Dakota. 


CITY  AND  TOWN  BONDS:  MUNICIPAL  LIABILITIES     209 

County  1  which  is  wholly  or  in  part  included  within  the  limits  of 
said  City  does  not  exceed  7  per  cent,  of  such  valuation,"  etc. 

600.  New  York  State  also  has  awakened  to  the  danger  of  debt 
duplication  and  by  recent  constitutional  amendment  "  any  debt 
hereafter  incurred  by  any  portion  or  part  of  a  city,  if  there  shall 
be  any  such  debt,  shall  be  included  in  ascertaining  the  power  of 
the  city  to  become  otherwise  indebted." 

601.  Net  Debt.  The  gross  debt  of  a  city,  in  itself  considered,  is 
of  very  little  significance,  any  more  than  "  accounts  payable  "  in 
industrial  corporations,  irrespective  of  "  accounts  receivable." 
What  we  wish  to  know  of  a  municipality  is  its  Real  Net  Debt  and 
its  Legal  Net  Debt.  The  Real  Net  Debt  is  the  residue  of  obligations 
which  are  not  balanced  by  assets  in  kind, — assets  that  make  the 
obligations  self-sustaining  and  thereby  prevent  them  from  being 
an  actual  charge  on  the  municipality.  The  Legal  Net  Debt,  in 
many  states,  is  that  which  the  legislatures  declare,  and  the  courts 
decide,  is  the  debt  within  the  meaning  of  the  provisions  regulating 
the  debts  of  municipalities. 

602.  The  Legal  Debt,  in  many  states,  is  based  in  a  crude  way 
on  the  Real  Net  Debt.  Since,  however,  there  may  be  difference  of 
opinion  as  to  what  obligations  are  assuredly  self-supporting,  we 
find  different  interpretations  of  Legal  Net  Debt,  or  "  Debt."  Thus 
the  Supreme  Court  of  Pennsylvania  holds  that  the  real  debt  of  a 
municipality  in  that  state  (which  shall  be  limited  to  7  per  cent,  of 
the  assessment)  is  the  authorized  debt  less  the  amount  of  mu- 
nicipal certificates  purchased  and  uncanceled  in  the  sinking  fund. 
But  even  this  doctrine  that  municipal  securities  alive  in  the  sink- 
ing fund  should  be  subtracted  is  not  accepted  in  all  states. 

603.  It  will  be  seen  that  cities  and  towns  in  Pennsylvania  are 
not  permitted  to  recognize  the  self-supporting  nature  of  water 
bonds,  by  subtracting  the  amount  of  them  from  the  authorized 
debt  in  determining  the  limit  of  indebtedness.  The  same  is  true 
in  Rhode  Island,  Montana,  California,  and  not  a  few  other  states. 
Formerly  the  constitution  of  Missouri  was  equally  conservative, 
but  by  the  amendments  of  1902  the  two  leading  cities,  St.  Louis 
and  Kansas  City,  are  permitted  to  exempt  the  water  debt.  Further- 
more cities  of  from  2,000  to  30,000  inhabitants  may  by  vote  exceed 
the  debt  limit  with  issues  of  water  and  light  bonds  to  the  amount 
of  5  per  cent,  of  the  taxable  property.    This  is  equivalent  to  a  re- 

1  See  §§  509,  510. 


210    CITY  AND  TOWN  BONDS:  MUNICIPAL  LIABILITIES 

si riited  permission  to  ignore  these  loans  in  computing  the  next 
debt.  The  following  also  are  among  those  states  in  which,  by 
constitution,  statute,  or  charter,  some  or  all  municipalities  may, 
in  computing  their  net  debt,  omit  water  loans,  wholly  or  to  a  percent- 
age: Alabama,  Colorado,  Massachusetts,  Montana.  Missouri,  New 
Hampshire,  New  York,  North  and  South  Dakota,  South  Carolina, 
Utah,  Washington,  and  Wyoming.  New  York  City  may  except  water 
loans  incurred  since  January  1,  1904.  The  municipalities  in  some 
of  these  states  may  in  like  manner  except  sewerage  and  lighting 
obligations  when  incurred  for  plants  municipally  owned  and  op- 
erated. Municipal  corporations  in  Illinois  that  have  reached  their 
debt  limit  may  not  issue  water  bonds  to  exceed  that  limit;  but 
for  the  improvement  or  extension  of  waterworks,  they  may  issue 
certificates  payable  out  of  the  earnings  of  the  plants. 

604.  The  Revised  Statutes  of  Massachusetts  fairly  represent 
these  states  mentioned.  Net  indebtedness  in  Massachusetts  is  de- 
fined as  the  indebtedness  of  a  county,  city,  town,  or  district,  omit- 
ting debt  created  for  supplying  the  inhabitants  with  water,  and 
other  debts  exempted  from  the  operation  of  the  law  limiting  their 
indebtedness,  and  deducting  the  amount  of  the  sinking  funds  avail- 
able for  the  payment  of  the  indebtedness  included.  The  phrase 
italicized  calls  attention  to  the  fact  that  in  subtracting  the  water 
debt,  or  any  other  legally  excludable  debt,  it  is  not  the  gross,  but 
the  net  debt  which  is  subtracted.  In  other  words,  care  should  be 
taken  that  the  sinking  funds  of  the  excluded  debts  should  not 
be  twice  deducted. 

605.  As  previously  stated,  the  various  debits  of  a  transient 
nature  are  frequently  excluded  in  ascertaining  net  debt.  Of  such, 
in  the  new  constitution  of  Alabama,  are  temporary  loans,  to  be 
paid  within  one  year,  made  in  anticipation  of  the  collection  of 
taxes,  and  not  exceeding  one-fourth  of  the  annual  revenues.  Maine 
and  some  other  states  do  not  limit  the  amount  of  temporary  loans 
which  may  be  excluded.  In  line  with  the  common  rule  the  Su- 
preme Court  of  Georgia  holds  that  unaccrued  interest  is  not  to  be 
included.  Almost  invariably  municipal  corporations,  as  in  Mon- 
tana, may  incur  new  indebtedness  to  refund  existing  indebtedness, 
if  the  total  after  refunding  will  be  within  the  constitutional  limita- 
tion, even  though  both  taken  together  would  exceed  it. 

606.  In  the  rare  cases  in  which  bonded  debt  only  is  limited,  and 
there  is  no  restriction  upon  floating  debt,  the  bondholders  cannot, 
by  mandamus  or  injunction,  restrain  the  creation  of  floating  debt, 


CITY  AND  TOWN  BONDS:  MUNICIPAL  LIABILITIES     211 

and,  unless  taxes  have  been  specifically  pledged  for  the  payment 
of  the  bonds,  or  unless  the  legislature  has  made  them  a  first  charge, 
the  holders  of  floating  indebtedness  have  an  equal  right  with  the 
holders  of  bonds. 

The  holders  of  floating  indebtedness  are  general  creditors,  who 
may  press  demands  for  payment  with  a  legal  suit  and  become 
judgment  creditors.  The  bondholder  in  the  absence  of  default  on 
his  paper,  and  prior  to  its  maturity,  has  no  ground  for  attempting 
the  collection  of  his  claim  against  the  municipality.  It  is  quite 
conceivable,  in  a  school  district  for  instance,  that  the  claims  of 
judgment  creditors  might  accumulate  to  such  an  extent  as  to  en- 
danger the  district's  solvency  and  vitiate  the  interest  of  its  bond- 
holders. Hence  the  necessity,  for  safety,  of  having  the  floating 
debt  construed  within  the  debt  limits. 

607.  It  is  patent  from  these  judicial  and  legislative  interpreta- 
tions offered  in  illustration  that  the  legal  Net  Debt  of  a  munici- 
pality, upon  which  its  debt  limitation  is  based,  is  often  a  thing 
quite  apart  from  the  Real  Net  Debt.  On  the  one  hand  the  mu- 
nicipality may  be  permitted  to  exclude  from  the  net  debt  issues 
that  are  not  self-supporting,  and,  on  the  other  hand,  it  may  be  en- 
joined from  excluding  issues  that  arc  self-supporting. 

608.  The  Supreme  Court  of  Illinois  has  decided  that  the  World's 
Fair  bonds  shall  not  be  computed  as  part  of  the  net  debt.  The 
amount  of  these  bonds  is  $4,293,000,  or  six-sevenths  of  the  amount 
of  the  water  debt,  or  of  the  amount  of  the  city's  sinking  funds. 
The  sinking  fund  bonds  and  water  debt  are,  of  course,  revenue- 
producing;  but  the  World's  Fair  bonds  are  dead  weight,  and  are 
not  held  in  as  high  esteem  and  do  not  sell  as  well  as  Chicago's 
other  direct  obligations.  This  is  a  gross  perversion  of  municipal 
accounting,  whatever  justification  it  may  have  on  grounds  of 
expediency.  St.  Louis  has  World's  Fair  bonds  and  water 
bonds  in  practically  the  same  amounts,  respectively,  as  Chi- 
cago; but  the  Fair  bonds  of  St.  Louis  are  included  in  the  net 
debt. 

609.  The  best  illustrations  of  self-supporting  issues  that  may 
not  be  deducted  from  the  gross  debt  in  finding  the  net  come  from 
states  like  Pennsylvania,  in  which  water  debt  may  not  be  sub- 
tracted. It  is  to  be  observed,  however,  that  the  usual  bond  cir- 
cular takes  little  heed  of  either  the  real  or  the  legal  net  debt, 
but  makes  it  a  practice  to  take  the  general  or  the  total  debt,  sub- 
tract from  it  the  gross  water  debt,  and  probably  the  sinking  funds, 


I'll'    CITY  AND  TOWN  BONDS:  MUNICIPAL  LIABILITIES 

and  call  the  remainder  the  net  debt.  The  justification  for  this  is 
that  further  refinement  of  municipal  accountancy  would  be  lost 
on  the  average  bond  buyer.  No  such  liberties  would  be  openly 
tolerated  in  presenting  the  financial  statements  of  private  cor- 
porations. 

610.  Portland,  Maine,  offers  a  good  illustration  of  a  business- 
like system  of  municipal  accounting,  so  far  as  it  determines  net 
debt.  The  total  debt  of  Portland  includes  the  usual  city  loans, 
bonds  matured  but  not  presented  and  retired,  and  assumed  bonds 
of  the  annexed  city  of  Deering.  (St.  Louis  excludes  the  bonds  of 
St.  Louis  County,  merged.)  From  this  total  Portland  deducts,  to 
find  net  debt,  the  conservatively  estimated  market  value  of  her 
available  assets,  consisting  of  cash,  gas  company  stock,  and  the 
stock  of  the  Portland  and  Ogdensbnrg  Railroad,  guaranteed  under 
lease  by  the  Maine  Central. 

611.  A  form  of  accounting  such  as  that  in  Portland,  under 
which  the  legal  and  the  real  net  debt  approximate  each  other,  is 
not  possible  under  the  laws  of  many  states,  for  it  is  liable  to 
abuse.  And  yet  it  makes  us  realize  how  we  may  mislead  when  we 
attempt  to  compare  the  debts  of  cities  without  comparing  also  the 
revenues  of  the  properties  for  which  the  debts  were  incurred;  or 
when,  without  making  proper  allowances,  we  attempt  to  compare 
the  past  debt  of  a  city,  which  represents  as  a  rule  expenditures 
which  make  no  direct  pecuniary  return,  with  the  present  debt, 
which  in  part  may  represent  highly  productive  assets,  as  in  New 
York. 

612.  New  York  City  has  recently  sought  and  obtained  from  the 
legislature  an  amendment  to  the  constitution  providing  for  the 
exclusion  from  its  debt  limit  of  obligations  hereafter  incurred  for 
public  improvements  that  yield  to  the  city  current  net  revenue 
in  excess  of  the  interest  and  sinking  funds  on  such  obligations; 
also  for  the  exclusion  from  the  debt  limit  of  any  obligation  here- 
tofore incurred  by  the  city  for  any  rapid  transit  or  dock  invest- 
ments to  the  extent  to  which  their  net  revenues  shall  meet  the  in- 
terest and  sinking  fund  thereof.  This  course  commends  itself  as 
more  rational  than  that  of  raising  the  debt  limit  to  14  per  cent.,  as 
suggested,  because,  although  the  net  result  in  dollars  and  cents  may 
be  the  same,  it  places  all  kinds  of  "self-supporting"  debt  on  a 
common  basis  of  inventory,  and  is  another  step  in  the  direction 
of  more  uniform  municipal  accounting.  The  danger  from  a  spread 
of  the  custom  is  that  cities  will  receive  legislative  permission  to 


CITY  AND  TOWN  BONDS:  MUNICIPAL  LIABILITIES     213 

exclude  from  the  net  debt  obligations  that  eventually  will  not  prove 
self-sustaining. 

613.  Sinking  Funds.  Sinking  Funds,  even  more  commonly  than 
water  loans,  are  excepted  from  the  gross  debt  in  finding  the  net. 
To  be  sure  it  sometimes  happens  that  the  courts  will  hold,  as  in 
Montana,  that  "  indebtedness  "  as  used  in  the  section  of  the  state 
constitution  limiting  debts,  means  what  a  city  owes,  "  irrespective 
of  demands  it  might  hold  against  others,"  but  the  interpretation 
that  admits  of  this  subtraction  of  sinking  funds  is  fairly  general. 
New  York  State  in  1886  was  the  scene  of  the  battle  royal  over  sink- 
ing fund  accounting  in  its  relation  to  net  debt;  and  the  case  was 
won  in  the  Court  of  Appeals  only  after  a  year's  struggle.  One  of  the 
results  was  the  creation  in  1903,  in  New  York  City,  of  issues  of 
General  Fund  bonds  to  absorb  the  surplus  revenues  arising  from 
the  crude  sinking  fund  of  the  old  city.  Since  these  bonds,  of  which 
over  |40,000,000  are  now  outstanding,  are  destined  only  for  the 
sinking  fund,  the  interest  from  them  helps  to  keep  down  the  tax 
rate.  In  1906  New  York  bought  nearly  |12,000,000  of  its  own 
issues  for  its  sinking  funds.  To  include,  therefore,  the  General 
Fund  bonds  in  the  city  debt  would  be  the  height  of  absurdity. 

614.  If  the  sinking  fund  method  of  meeting  debt  is  to  be  used 
at  all,  it  is  best  to  protect  each  bond  issue  separately,  by  creating 
a  special  sinking  fund  for  it  from  the  proceeds  of  a  special  bond 
tax  voted  before  or  at  the  time  of  the  issue.  The  list  of  states  re- 
quiring this  method  has  been  given  in  §  534.  If  the  fund  is  a  general 
fund  it  is  probably  established  by  act  of  legislature  "  by  raising 
annually  a  sum  which  will  produce  an  amount  equal  to  the  sum 
of  the  principal  and  interest  of  said  bonds  at  their  maturity."  As 
operated  in  Massachusetts  the  sinking  fund  is  not  designed  to  meet 
the  interest.  But  since  it  is  notorious  that  sinking  funds,  mu- 
nicipal and  corporation,  are  appropriated  for  other  than  the  uses 
for  which  they  are  instituted,  the  statute  should  explicitly  state 
they  are  "  to  be  used  for  no  other  purpose  than  the  payment  of  such 
debt." 

615.  When  a  municipality  has  outstanding  a  considerable  num- 
ber and  variety  of  loans,  it  is  the  custom  to  purchase  its  own  se- 
curities to  be  kept  alive  in  the  sinking  fund.  Jersey  City  invests 
in  nothing  but  its  own  bonds.  Many  another  city  likewise.  It  is 
evident  that  this  course  does  nothing  more  than  reduce  the  real 
debt  of  the  municipality.  It  is  fairly  comparable  to  the  course  of 
a  man  who  borrows  on  his  note  and  later  reduces  his  indebtedness 


214     CITY  AND  TOWN  BONDS:  MUNICIPAL  LIABILITIES 

by  buying  back  his  note,  or  part  of  it,  and  owing  himself  the  sum 
bought  back,  and  paying  himself  interest  on  the  sum  until  the 
maturity  date.  There  arc  places  of  refuge  and  quiet  for  men 
who  would  seriously  pursue  such  a  practice.  But  cities  do  com- 
monly, and  municipal  sinking  funds  are  not  yet  a  byword  and  a 
jest. 

"  If  the  Sinking  Fund  is  invested  in  the  debtor's  own  bonds  or  obligations,  its 
existence  is  not  of  the  least  advantage  to  the  creditor.  It  gives  him  no  additional 
security, — legal,  equitable,  or  honorary.  It  is  a  worthless  device  so  far  as  he  is 
concerned."1 

616.  Moreover  a  device,  like  that  in  New  York,  by  which  a  city 
is  permitted  to  sell  its  own  bonds  direct  to  the  sinking  fund,  is 
not  only  worthless,  but  pernicious ;  for  it  permits  "  a  city  to 
market  its  bonds  to  itself,  when  the  credit  of  the  city  or  the 
state  of  the  money  market  might  be  such  that  the  bonds  would  not 
sell  outside."  It  is  understood,  of  course,  that  the  plan  may  be 
pernicious,  and  yet  the  least  of  several  possible  evils  under  exist- 
ing circumstances.  This  is  the  case  in  the  New  York  General  Fund 
bond  issues.  On  the  general  grounds  Minneapolis  was  refused  per- 
mission to  sell  its  bonds  to  the  Board  of  Sinking  Fund  Commis- 
sioners, although  no  statute  forbade  it,  the  Chief  Justice  of  Min- 
nesota contending  that  "  such  a  purpose  is  so  radically  inconsis- 
tent with  a  sinking  fund,  and  so  destructive  of  the  purposes  to  be 
conserved  by  its  maintenance,  that  it  must  be  held  that  the  pro- 
hibition is  implied." 

617.  For  a  municipality  to  sell  its  bonds  to  the  sinking  fund  is 
the  same  thing  as  for  the  municipality  to  borrow  money  from  the 
sinking  fund.  It  was  this  violation  of  fundamental  principles  that 
brought  Pitt's  famous  English  fund  to  grief. 

618.  If  the  object  of  a  sinking  fund  is  to  lay  aside  money  year 
by  year  toward  the  payment  of  a  debt  at  some  future  time,  the 
money  in  the  fund  is  most  safely  disposed  for  accumulation  until 
that  time,  and  the  creditors  are  best  secured,  by  dispersing  it  in 
the  purchase  of  various  strong  securities  which  to  the  least  pos- 
sible extent  are  subject  to  the  control  of  the  debtor  corporation. 
With  this  in  view  the  funds  of  Providence,  Rhode  Island,  are  con- 
vertible into  bonds  of  the  Federal  Government,  and  of  the  state 

1  The  Metropolitan  Debts  of  Boston  and  Vicinity,  Chandler.  (Extracted  from 
The  Sinking  Fund,  Browne.)  Other  quoted  paragraphs  under  the  topic  of 
"  Sinking  Funds  "  are  from  Chandler,  unless  otherwise  attributed. 


CITY  AND  TOWN  BONDS:  MUNICIPAL  LIABILITIES     215 

governments  of  New  England,  and  of  the  cities  of  Rhode  Island, 
and  of  16  other  cities  of  very  high  credit.  But  "  the  bonds  of  each 
of  said  cities  shall  be  a  lawful  investment  only  so  long  as  its  in- 
debtedness, less  its  water  debt  and  sinking  funds,  shall  not  ex- 
ceed 7  per  cent,  of  its  assessed  valuation." 

"  The  creditors'  legal  rights  are  very  little,  if  at  all,  strengthened  by  a  sinking 
fund  invested  in  outside  securities,  so  long  as  they  remain  under  the  control  of  the 
debtor  himself,  or  within  reach  of  his  general  creditors."1 

You  cannot  hold  a  debtor  to  a  contract  made  with  himself. 

619.  How  misplaced  is  public  confidence  in  the  efficacy  of  sink- 
ing funds  (which  are  almost  invariably  in  the  control  of  the  debtor), 
may  be  evinced  by  a  survey  of  financial  history.  "  The  suspension 
of  a  sinking  fund  is  at  times  deliberate,  and  is  essential  in  sound 
finance  if  money  must  be  borrowed  to  maintain  it;  for  to  borrow 
to  keep  up  the  Sinking  Fund  is  a  purely  fictitious  operation,  which 
really  adds  to  the  debt  it  in  no  wise  reduces."  And  so  we  find  that 
England,  after  the  War  with  Egypt,  and  after  the  Transvaal  War, 
and  the  United  States,  during  and  for  some  years  after  the  Civil 
War,  suspended  payments.  Indiana,  in  1905,  by  act  of  legislature, 
suspended  taxes  raised  for  sinking  funds  till  1908.  Pennsylvania, 
by  the  constitution  of  1873,  makes  explicit  exception  to  the  in- 
tegrity of  her  sinking  fund  "...  and  unless  in  case  of  war,  inva- 
sion, or  insurrection,  no  part  of  the  said  sinking  fund  shall  be  used 
or  applied  otherwise  than  in  the  extinguishment  of  the  public 
debt." 

620.  Yet,  after  all  is  said,  because  of  the  fact  that  sinking  funds 
directly  or  indirectly  reduce  the  amount  of  obligations  in  the  hands 
of  a  city's  creditors,  it  is  right  that  they  should  ordinarily  be  de- 
ducted from  the  gross  debt  in  computing  the  net. 

621.  Sinking  Funds  Versus  Serial  Repayment.  If  not  sinking 
funds,  what  then?    The  alternative  is  Serial  Repayment. 

In  1872  West  Virginia  accepted  a  new  constitution  requiring 
that  "  the  payment  of  any  liability,  other  than  that  for  the  ordi- 
nary expenses  of  the  State,  shall  be  equally  distributed  over  a  period 
of  at  least  twenty  years."  Ten  years  later,  Massachusetts,  by 
statute,  extended  to  her  municipalities  the  option  of  serial  pay- 
ment. "  A  city  or  town,  instead  of  establishing  a  sinking  fund, 
may  vote  to  provide  for  the  payment  of  any  debt  by  such  annual 

1  The  Sinking  Fund,  Browne. 


216     CITY  AND  TOWN  BONDS:  MUNICIPAL  LIABILITIES 

proportionate  payments  as  will  extinguish  the  same  at  maturity." 
About  twenty-five  of  the  leading  cities  and  towns  have  availed 
themselves  of  the  privilege;  and  the  demonstrable  benefits  that  have 
accrued  have  been  the  means  of  influencing  many  municipalities  in 
other  parts  of  the  country  to  adopt  the  same  policy.  A  large  part 
of  the  obligations  of  Elmira,  New  York,  are  serial  in  maturity,  and 
the  city  is  thereby  enabled  to  do  away  with  sinking  funds.  Salem, 
Massachusetts,  closed  her  sinking  fund  account  in  1908,  with  re- 
joicing. 

622.  Sinking  funds  do  not  amortize  a  debt;  they  merely  convert 
it,  or  offset  it.  The  only  true  amortization  is  extinction.  The 
only  way  to  sink  a  debt  is  to  pay  it.  The  simple,  rational,  and 
economic  method  of  extinguishing  a  debt  is  to  pay  it  in  approxi- 
mately equal  periodic  instalments.  This  is  the  serial  bond 
method. 

623.  Sinking  funds  are  not  only  liable  to  misappropriation,  un- 
wise investment,  suspension,  and  the  like,  but  tJiey  are  costly. 
Their  average  earnings  are  little,  if  any,  over  3  per  cent.  Serial 
bonds  require  a  minimum  of  expense  and  produce  a  maximum  of 
security.  "  When  a  bond  issue  is  serial  the  investment  grows 
safer  as  it  grows  older." 

624.  The  following  two  tables,  compiled  by  Mr.  Alfred  D.  Chand- 
ler,1 show  the  difference  in  actual  interest  paid  out,  and  in  cost, 
of  a  bond  issue  of  $1,000,000,  at  different  interest  rates  and  dura- 
tions. 

The  first  table  wrorks  out  the  difference  in  cost  of  a  loan  of 
$1,000,000  for  20  years,  bearing  the  interest  rate  of  4  per  cent., 
on  the  assumption  that  the  sinking  fund  can  earn:  (a)  3  per  cent; 
(b)  3£  per  cent.;  (c)  4  per  cent. 

$1,000,000  at  4$  for  20  years.       comparison  between  sinking 
Fund  and  Serial  Bond  Methods 

By  the  Sinking  Fund  method  the  interest  at  4^  is     .     .     $800,000 
"         Serial  Bond        "  "  "...       420,000 


Difference  in  interest  in  favor  of  Serial  Bonds     .     .     .     $380,000 

1  The  Metropolitan  Debts  of  Boston  and  Vicinity.  Sinking  Fund  and  Serial 
Bond  Methods  Compared.  Printed  by  the  Town  of  Brookline,  Mass.,  1905.  Many 
other  interesting  tables  are  to  be  found  there. 


CITY  AND  TOWN  BONDS:  MUNICIPAL  LIABILITIES     217 

(a) 

$1,000,000  Sinking  Fund  requirements  for 
20  years,  on  a  3#  basis,  the  decimal  for  $1 
being    .038654 1734,426 

$1,000,000  at  4#  for  20  years,  interest     .      .        800,000 


Cost  of  loan,  Sinking  Fund  method     .     .  $1,534,426 

$1,000,000   20   year    Serial   Bond,    1-20,    or 

$50,000,  payable  yearly $1,000,000 

Interest  (annually  diminishing)  total  at  4$       420,000 


Cost  of  loan,  Serial  Bond  method     .     .     .  1,420,000 


(b) 

$1,000,000  Sinking  Fund  requirements  for 
20  years,  on  a  3-|#  basis,  the  decimal  for 
$1  being  .036657~ $696,483 

$1,000,000  at  4#  for  20  years,  interest     .     .       800,000 


(c) 

$1,000,000  Sinking  Func  requirements  for 
20  years,  on  a  4$  basis,  the  decimal  for  $1 
being  .034749 $660,231 

$1,000,000  at  4#  for  20  years,  interest     .     .        800,000 


Difference  in  cost  in  favor  of  Serial  Bond  method     .     .     $114,426 


Cost  of  loan,  Sinking  Fund  method     .     .  $1,496,483 

"  "       Serial  Bond        "  .      .  1,420,000 


Difference  in  cost  in  favor  of  Serial  Bond  method     .     .     $     76,483 


Cost  of  loan,  Sinking  Fund  method     .     .  $1,460,231 

"  "        Serial  Bond        "  .     .  1,420,000 


Difference  in  cost  in  favor  of  Serial  Bond  method     .      .     $     40,231 
The  second  table  shows,  without  detail  of  operations,  the  differ- 


218     CITY  AND  TOWN  BONDS:  MUNICIPAL  LIABILITIES 

ence  in  interest  and  cost  of  a  $1,000,000  loan  at  both  3  and  4  per 
cent.,  for  durations  of  20,  40,  and  50  years. 


$1,000,000  at  3  per  cent. 

DIFFERENCE    IN    lllt<-ri-»t    IN    FAVOR 

op  Serial  Bonds 

$1,000,000  at  4  per  cent. 

Difference  in  Interent  in  Favor 
of  Serial  Bonds 

20  Years 

40  Years 

50  Years 

20  Years 

40  Years 

50  Years 

$285,000 

$585,000 

$735,000 

$380,000 

$780,000 

$980,000 

Difference  in  Cont  in  Favor 
of  Serial  Bonds 

Difference  in  Cost  in  Favor 
of  Serial  Bonds 

Sinking  Fund 

20  Years* 

40  Yearst 

50YeareJ 

20  Years* 

40  Yearst 

50  YearsJ 

On  3  per  cent,  basis.  . 

"   3i      " 

<<  ^        .i            it 

$19,426 

$109,199 
51,791 

$173,305 

111,908 

58,057 

$114,426 

76,483 
40,231 

$304,199 
246,79 i 

194,7  fir, 

$418,305 
356,908 

303,057 

*  Decimal  for  19  years,  and  19  payments.  t  Decimal  for  39  years,  and  39  payments. 

%  Decimal  for  49  years,  and  49  payments. 


If  the  number  of  payments  were  to  equal  the  full  number  of  years, 
there  would  be  an  increase  over  the  above  in  the  saving  in  favor  of 
Serial  Bonds,  the  ratio  of  such  increase  being  larger  with  the  Bonds 
of  a  shorter  term. 

If  both  the  decimal  taken  and  the  number  of  payments  made  each 
equal  the  full  number  of  years,  there  will  still  be  a  large  gain  in 
favor  of  the  Serial  Bonds. 

To  take  the  extreme  case,  it  costs  a  municipality  $418,305  more 
to  issue  a  $1,000,000,  50-year,  4  per  cent,  loan,  to  be  acquitted  at 
the  end  of  the  period  by  sinking  fund  accumulations,  provided  the 
sinking  fund  earns  the  usual  3  per  cent.,  than  it  costs  to  pay  off 
one-fiftieth  of  the  loan,  with  interest,  each  year.  It  should  be 
mentioned,  however,  that  a  "  straight "  50-year  loan  would  bring 
a  slightly  higher  price  than  a  serial  loan,  but  the  difference  would 
be  only  a  trifling  part  of  $418,305.  Bearing  this  sum  in  mind,  and 
remembering  that  New  York  City  has  very  many  millions  of  50- 
year  loans  outstanding,  one  can  readily  appreciate  the  tremendous 
loss  to  the  city  which  the  sinking  fund  policy  occasions.  On 
October  31,  1910,  New  York  had  $249,557,055  in  her  various  sink- 
ing funds. 


CITY  AND  TOWN  BONDS:  MUNICIPAL  LIABILITIES     219 

625.  The  Redemption  Privilege.  Bonds  that  mature  serially  are 
almost  never  refunding,  for  the  method  of  amortization  hardly 
admits  of  it;  and  refunding  defeats  the  very  purpose  of  serial  re- 
tirement. Indeed,  refunding  is  often  denied  by  law.  But  still 
something  is  gained  by  a  municipality  that  does  not  mature  its 
bonds  serially,  if  the  issues  are  made  subject  to  call;  and  it  is 
significant  that  very  many  cities  which  are  given  in  part  to  serial 
amortization,  have  all  their  straight  loans  callable. 

626.  Bond  issues  may  be  callable  either  in  whole  or  in  part; 
at  the  time  of  issuance  or  at  a  given  date;  or  on  or  after  a  given 
date;  or  they  may  be  callable  in  a  certain  amount  each  year. 
Almost  all  of  the  many  loans  of  La  Crosse,  Wisconsin,  are  callable 
any  time  during  the  ten  years  immediately  prior  to  their  maturity ; 
of  Annapolis,  Maryland,  any  time  after  their  fifth  year  of  life. 
Warren,  Pennsylvania,  has  loans  callable  in  blocks  of  $11,000  every 
5  years.  Pittsburg,  in  the  same  state,  has  no  end  of  variations  on 
the  theme  of  redemption. 

627.  Unlike  corporation  bonds,  municipals  are  usually  redeem- 
able at  par,  if  at  all.  The  privilege  of  redemption  makes  it  possible 
for  a  city,  when  in  funds,  to  cancel  a  portion  of  its  debt  with  the 
surplusage,  and  avoid  the  evils  of  a  large  sinking  fund.  Much 
the  same  result  would  be  attained  by  buying  the  bonds  in  the  open 
market,  as  sinking  funds  often  do,  but  since  municipal  bonds  are 
seldom  permitted  by  law  to  be  issued  at  a  price  below  par,  it  is 
not  always  possible  for  the  city  to  buy  them  back  below  par;  and 
the  sinking  fund  usually  has  to  pay  slightly  more  than  the  market 
price  if  it  buys  openly. 

628.  Then  again  the  privilege  of  recall  makes  it  possible  for  a 
municipality  to  avail  itself,  without  loss,  of  any  general  lowering 
of  interest  rates,  or  of  any  lowering  in  its  own  particular  case, 
due  to  gain  in  its  credit.  One  still  sees  many  irredeemable  issues 
of  municipal  6s  and  7s  that  were  put  out  in  the  seventies  and 
eighties.  Most  of  these  long  since  would  have  been  retired  or  re- 
funded, if  they  had  been  callable  at  par.  Any  experience  of  this  sort 
is  likely  to  be  reflected  in  the  policy  of  a  community.  If  one  issue 
of  a  city  is  callable  we  may  expect  to  find  most  of  them  callable,— 
at  least  most  recent  issues.  Thus  in  Shenandoah  and  Shenandoah 
School  District,  Pennsylvania.  And  if  the  practice  gains  any  head- 
way in  one  section,  it  is  likely  to  become  the  settled  policy  of  the 
state.  Almost  all  of  the  municipal  bonds  of  Wyoming  are  subject 
to  call,  and  the  majority  of  the  remainder  are  serial. 


220    CITY  AND  TOW  X   BONDS:  MUNICIPAL  LIABILITIES 

The  privilege  of  redemption  plays  no  part  in  the  net  debt  of 
municipalities,  but  as  a  topic  concomitant  with  sinking  funds  and 
serial  repayment  it  is  logically  treated  here. 

629.  Debt  Limitations  and  Restrictions.  Having,  now,  some  work- 
ing information  on  appraised,  taxable  wealth,  and  of  legally  de- 
fined debt,  we  are  prepared  to  consider  each  in  its  relation  to  the 
oilier;  for  their  relation,  expressed  in  percentage  as  a  ratio,  is  the 
usual  measure  of  the  debt  permitted  by  law,  and  introduces  us 
presently  to  the  study  of  legality. 

First,  however,  let  it  be  said  that  certain  states  have  almost  no 
general  limitation  to  the  amount  of  debt  that  they  may  incur. 
They  are 

Arkansas,  Idaho,1  Nebraska,  Tennessee, 

Connecticut,  Maryland,  Nevada,  Texas, 

Delaware,  Michigan,  New  Jersey,  Virginia. 

Florida,  Minnesota,  North  Carolina, 

The  only  important  limitation  in  Minnesota  and  Nebraska  is  that 
all  municipalities  shall  be  restricted  in  respect  to  railroad  aid  to 
from  5  to  15  per  cent,  of  the  assessment.  New  York  State  puts 
a  limitation  upon  the  debts  of  counties  and  cities,  but  none  upon 
the  minor  civil  divisions. 

630.  The  source  of  the  debt  limitation  varies.  The  territories, 
of  course,  have  been  subject  to  the  will  of  Congress.  For  states 
the  constitutional  limitation  has  been  the  most  desirable,  for  that 
is  least  liable  to  abrogation.  Also  if  the  constitution  is  not  suffi- 
ciently restrictive  it  may  be  supplemented  by  legislation.  We  find 
constitutional  limitations  in  Kentucky,  Louisiana,  Montana,  New 
York  (for  counties  and  cities),  Oklahoma,  Montana,  South  Carolina, 
South  Dakota,  Utah,  Washington,  West  Virginia,  Wisconsin,  etc. 

631.  Yet  more  often  than  not  the  power  of  debt  limitations  and 
of  other  restrictions  has  been  delegated,  specifically  or  otherwise, 
to  the  legislatures.  By  this  arrangement  legislative  limitation  is 
more  self-corrective  and  discretionary,  but  it  is  liable  to  abuse. 
Some  of  the  New  England  state  legislatures  have  been  free  in 
their  employment  of  the  discretionary  power,  particularly  in  the 
passage  of  special  enabling  acts.  When  custom  sanctions  this  the 
debt  limit  is  of  very  little  value.     North  Adams,  Massachusetts, 

1  This  does  not  take  into  account  very  special  legislative  or  charter  limits, 
e.g.  in  Bois6  City,  15  per  cent. 


», 


CITY  AND  TOWN  BONDS:  MUNICIPAL  LIABILITIES     221 

has  more  loans  outside  than  inside  the  limit,  entirely  apart  from 
the  water  bonds.  New  Bedford  has  a  debt  of  $3,939,000  outside. 
In  1903  the  legislature  of  New  Hampshire  suspended  the  Municipal 
Bond  Act  of  1895  to  permit  Portsmouth  to  build  a  high  school. 

632.  The  debt-limiting  power  has  been  delegated  in  whole  or  in 
part  to  the  legislatures  of  Kansas,  Maryland,  Massachusetts,  New 
York,  Michigan,  Nebraska,  New  Hampshire,  Ohio,  Oregon,  and 
other  states.  In  Maryland  and  Ohio  the  power  has  not  been  gen- 
erally exercised. 

633.  Charter  limitation,  being  freely  amenable  to  legislation,  is 
open  to  the  same  sort  of  objection  as  legislative  limitation,  if  not 
to  the  same  degree.  The  number  of  municipal  corporations  in 
which  the  principal  limitation  is  by  charter  is  not  relatively  large. 
It  is  the  only  sort  of  limitation,  however,  in  North  Carolina  and 
Tennessee.  When  the  charter  antecedes  the  present  constitution 
or  the  most  recent  municipal  bond  act,  it  is  generally  of  greater 
latitude,  as  in  Manchester,  Virginia;  but  sometimes  the  opposite 
is  the  case,  as  in  Danville,  and  Lynchburg,  Virginia. 

634.  The  Basis  of  the  Debt  Limitation  is  almost  always  a  per- 
centage of  the  assessed  valuation  of  all  the  taxable  property.  In 
New  York  State  and  in  Virginia  it  is  the  assessed  valuation  of  real 
estate  only.  In  Chicago  and  in  all  the  municipalities  of  Iowa  it  is 
a  percentage  of  the  full  or  actual  valuation,  irrespective  of  the 
assessment.    But  these  are  the  rare  exceptions  to  the  general  rule. 

635.  The  Degree  of  Limitation  may  be  fixed  (numerical),  or, 
more  commonly,  elastic  (percentile).  Oregon  is  the  only  state  which 
limits  its  municipalities  as  a  whole  to  fixed  amounts.  Counties  in 
Oregon  may  not  contract  debts  in  excess  of  f  5,000 ;  cities  and  towns, 
in  excess  of  $2,500,  without  legislative  sanction;  school  districts 
of  over  75,000  population,  in  excess  of  $100,000.  Smaller  school 
districts  have  a  5  per  cent,  limit.  Omaha,  Nebraska,  formerly  was 
limited  (with  exceptions  of  certain  issues)  to  $2,750,000,  but  now 
to  5  per  cent,  of  the  assessment.  Danville,  Virginia,  is  limited  h, 
$1,460,000. 

636.  It  is  obvious  that  the  better  form  is  the  common  elastic 
limitation  by  which  the  net  debt  may  not  be  incurred, — at  least 
without  consent  of  the  legislature, — to  exceed  a  certain  percentage 
of  the  assessment.  There  is  one  drawback,  however,  to  the  elastic 
form,  in  its  relation  to  legality.  Although  in  a  comparatively  new 
country  like  ours  the  tendency  of  the  assessment  (and  therefore  of 
the  debt-capacity)   to  increase  is  fairly  constant,  yet  at  times,  as 


222     CITY  AND  TOWN  BONDS:  MUNICIPAL  LIABILITIES 


from  a  local  catastrophe,  or  ill  a  period  of  serious  depression,  such 
as  that  of  the  early  nineties,  there  may  he  a  depletion  of  the  tax- 
able resources  which,  if  not  noted  by  the  municipal  creditor,  may 
leave  him  with  a  new  issue  of  illegal  obligations  on  his  hands. 
Helena,  Montana,  lloated  town  warrants  under  these  circumstances 
in  1893,  and  although  the  city  acted  in  perfectly  good  faith,  no  way 
has  yet  been  found  to  wipe  out  the  debt  incurred  at  that  time. 

637.  In  reading  the  subjoined  list  of  stales  with  their  debl 
limitations,  from  whatever  source,  it  must  be  remembered  that 
exceptions  to  the  limits  are  very  numerous;  that  the  limit  is  often 
raised  for  special  issues,  and  special  kinds  of  issues;  that  it  is 
rated  on  different  bases  of  valuation;  that  it  is  often  subject  to 
suspension  at  the  will  of  the  legislatures  and  on  the  vote  of  the 
people.  For  instance,  although  the  debt  limit  in  Oklahoma  is  5 
per  cent.,  the  constitution  excepts,  and  does  not  limit  at  all,  the 
amount  of  debt  which  may  be  created  for  the  purchase  or  con- 
struction of  public  utilities.  When  two  percentages  are  given  they 
indicate  the  ordinary  minimum  and  maximum  limits  for  various 
kinds  of  municipalities,  or  perhaps  for  various  kinds  of  issues, 
or  else  the  first  number  represents  the  nominal  limits  and  the 
second,  the  limit  including  issues  authorized  by  popular  vote. 
Therefore  the  table  is  almost  useless  for  purposes  of  comparison : 


Per  cent. 

Alabama 3|-8 

California 15 

Colorado   (coun- 
ties)   w 

Georgia    7 

Illinois    5 

Indiana  2 

Iowa   l-J-S 

Kansas   5-10 

Kentucky 2-10 

Louisiana 10 


Per  cent. 

Maine 5 

Massachusetts  .  .2^-5 

Mississippi 7-15 

Missouri 5 

Montana 3-5 

New  Hampshire. .  .5 
New  York  (cities 

and  counties)..  .10 
North  Dakota.... 5-8 

Ohio  4-8 

Oklahoma  5 


Per  cent. 

Pennsylvania   7 

Rhode  Island 3 

South   Carolina..  .  .8 
South  Dakota..  .5-23 

Utah   2-8 

Vermont 5-10 

Washington  .  ..If  10 
West  Virginia. . .  .2| 

Wisconsin 5 

Wyoming 2-6 


Also  Oregon  |2,500-|5,000. 

638.  Debt  creation  in  the  territories  was  subject  in  all  respects 
to  regulation  by  Congress.  The  former  limitation  in  Indian  Terri- 
tory is  worthy  of  note,  not  only  for  its  uniqueness,  but  because 
it  had  the  advantages  of  a  tax  restriction,  as  well  as  a  debt 
restriction,  with  none  of  the  disadvantages.     Cities  and  towns  in 


CITY  AND  TOWN  BONDS:  MUNICIPAL  LIABILITIES     223 

that  territory  of  over  2,000  population  might  become  bonded  for 
sewers,  waterworks,  and  schools  in  a  sum  not  to  exceed  "  an  amount, 
the  interest  on  which,  at  5  per  cent.,  would  be  liquidated  by  a  tax 
of  5  mills  upon  the  dollar  of  the  valuation  of  the  taxable  property." 

639.  It  is  curious  that  amid  all  the  vagaries  of  municipal  debt 
restrictions  no  state  has  recognized  in  the  limitations  it  imposes, 
the  dependence  of  the  debt-pajing  ability  on  the  margin  of  income 
over  current  municipal  expenses.  In  the  Province  of  Quebec,  how- 
ever, we  find  the  principle  is  recognized,  for  municipalities  there 
may  issue  bonds  and  provide  for  payment  out  of  the  general  funds 
only  until  such  time  as  the  total  amount  required  in  any  one  year 
for  interest  and  sinking  fund,  or  interest  and  instalment  of  prin- 
cipal, shall  exceed  50  per  cent,  of  the  total  annual  revenue.  When 
this  point  is  reached  debentures  may  be  issued  only  upon  the 
authority  of  the  Lieutenant  Governor  in  Council. 

640.  It  would  not  be  possible  to  mention  within  reasonable  limits 
of  space,  all  the  hindrances  and  bounds  which  are  placed  about 
the  incurrence  of  debt.  Most  states  expressly  prohibit  their  mu- 
nicipalities from  appropriating  moneys  for  assuming  the  debts  of, 
or  becoming  shareholders  in,  any  private  corporation,  company,  or 
person;  although  an  exception  often  is  made,  especially  in  New 
England,  in  favor  of  railroad  corporations,  on  the  ground  of  their 
public  nature  and  function.  The  loan  of  credit  in  any  guise  is  also 
prohibited  in  the  great  majority  of  states. 

641.  The  Referendum.  At  least  twelve  states  require  that  prior 
to  the  incurrence  of  any  new  funded  debt,  under  the  general  laws 
of  the  state,  at  least  any  debt  in  excess  of  the  year's  resources,  the 
measure  shall  be  submitted  to  the  vote  of  the  qualified  electors  of  the 
issuing  corporation.    These  states  are 

Alabama,  Idaho,  Oklahoma,  Texas, 

California,         Kentucky,  South  Carolina,  Utah, 

Colorado,  Missouri,  South  Dakota,  West  Virginia. 

642.  Seven  states  require  the  referendum  (or  the  petition,  which 
is  much  the  same  thing),  for  debts  incurred  in  excess  of  a  certain 
percentage  of  the  assessed  valuation.     They  are 


Georgia       above 

1-5  per  cent. 

Michigan 

above     2  per  cent 

Iowa                "      1 

1-4    "      " 

N.  Dakota 

a         5      a       u 

Washington     "       1 

1-2    "      " 

Virginia 

a       18      «       « 

Pennsylvania  "      2 

u        a 

224     CITY  AND  TOWN  BONDS:  MUNICIPAL  LIABILITIES 

In  addition  to  these,  New  Hampshire  requires  the  referendum 
for  all  political  divisions  except  cities. 

643.  A  majority  vote  is  by  no  means  sufficient  to  sanction  bond 
issues,  in  some  states.  About  as  many  require  a  two-thirds  vote 
as  require  the  majority  vote.  Oklahoma,  Washington,  and  West  Vir- 
ginia require  a  three-fifths  vote.  Colorado  and  Utah  limit  the  voting 
power  to  those  who,  in  the  year  preceding  the  election,  paid  a  prop- 
erty tax.  But  Iowa  requires  only  200  signatures  to  a  petition,  in 
cities  of  10,000  population  or  over. 

644.  The  submission  of  every  proposed  bond  issue  to  popular 
vote  is  the  best  warranty  of  good  faith.  By  what  the  people 
themselves  have  willed  they  are  more  likely  to  abide.  And  there 
will  be  less  unwisdom  in  the  accumulation  of  debts  when  they 
are  subject  to  the  publicity  of  a  municipal  election. 

645.  Here  and  there  we  come  across  laws  requiring  certain  mu- 
nicipalities, or  loans  of  certain  kinds,  or  loans  issued  under  certain 
conditions,  to  receive  special  legislative  sanction  before  flotation 
of  obligations.  In  the  eastern  provinces  of  Canada,  New  Bruns- 
wick, Nova  Scotia,  and  Prince  Edward  Island,  a  municipality 
must  get  a  special  act  of  legislature  every  time  it  makes  a  new 
bond  issue.  And  in  our  own  country  the  same  thing  is  true  for  all 
the  municipalities  of  Maryland. 

646.  Evasion  of  the  Debt  Limit.  In  closing  this  topic  it  should  be 
mentioned  that  several  devices  have  been  employed  to  evade  the 
restrictions  placed  about  the  power  to  contract  debts.  Notable 
among  these,  and  usually  successful  (though  not  in  Illinois  or 
Indiana),  is  the  plan  to  provide  municipal  waterworks  by  purchas- 
ing a  plant  privately  built, — subject  to  the  water  bonds  outstanding, 
which,  as  they  are  not  a  direct  municipal  obligation,  are  not  a  part 
of  the  municipal  debt.  Another  plan  is  to  issue  certificates  of  in- 
debtedness redeemable  from  the  proceeds  of  taxes  voted  at  the 
time,  or  prior  to,  the  issuance  of  the  certificates,  the  taxes  to  be 
collectable,  annually,  over  a  series  of  years.  All  loans  which  are 
the  outcome  of  such  dubious  methods  should  be  avoided.  They 
form  but  an  infinitesimal  portion  of  all. 


CHAPTER  XVIII 
CITY   AND  TOWN  BONDS:  VALIDITY  AND   GOOD   FAITH 

647.  Validity.  With  matters  of  validity  we  come  to  the  second 
of  the  three  main  topics  under  which  the  security  for  municipal 
loans  is  treated.  It  may  be  well  to  recall  the  order:  Financial 
Competency,  Validity,  and  Good  Faith. 

648.  It  has  been  said,  with  a  certain  element  of  truth,  that 
municipal  bonds  are  good  if  legal.  Whether  or  not  this  sums  up 
the  general  impression  of  municipals,  it  would  be  hard  to  say. 
The  emphasis  which  the  statement  places  upon  legality  is  not  with- 
out occasion.  Yet  legality  is  not  the  broad  term  for  the  thing 
signified ; — rather  validity :  for  a  bond  might  be  issued  which, 
though  not  in  complete  accordance  with  law,  would  still  be  a  valid 
obligation. 

649.  The  question  of  validity  almost  never  arises  for  federal 
government  or  private  corporation  loans.  But  there  are  so  many 
and  such  various  circumstances  under  which  municipal  bonds  are 
issued,  the  laws  are  so  obscure,  diverse,  and  in  many  cases  untested, 
the  municipal  corporations  so  various  in  character,  their  legislative, 
executive,  and  advisory  officers  so  often  woefully  inefficient,1  that 
opportunities  for  loss  to  investors  would  be  innumerable,  were 
the  purchasing  bond  houses,  through  their  experienced  attorneys, 
not  so  scrupulous  in  all  legal  details. 

650.  But  again  let  us  repeat  that  since  the  usual,  and  generally 
the  only,  fiscal  security  for  municipal  bonds  is  the  general  power 
of  taxation,  our  first  duty  is  with  this  tax  power,  its  scope  and 
limitations,  and  its  relation  both  to  the  wealth  it  levies  upon,  and 
the  debts  it  is  to  sustain  and  discharge.  Validity,  in  general,  is 
secondary. 

"The  Supreme  Court  of  the  United  States  .  .  .  has  upheld  the  validity  of 
bonds  which  have  been   issued  in  violation   of   all   requirements  of  law;    bonds 

1  A  perusal  of  some  of  the  author's  correspondence  with  municipal  officers 
would  be  a  profitable  and  sobering  discipline  to  advocates  of  the  municipal 
ownership  and  operation  of  our  public  utilities. 

225 


22G     CITY  AND  TOWN  BONDS :  VALIDITY  AND  GOOD  FAITH 

that  have  been  issued  in  excess  of  the  constitutional  limit  of  indebtedness;  bonds 
that  have  been  issued  in  violation  of  other  constitutional  requirements.  But 
that  court  is  powerless  when  it  reaches  the  question  of  remedies,  when  the 
statutes  of  the  state  fail  to  provide  a  sufficient  tax  levy,  or  when  they  ex- 
pressly restrict  the  levy  to  such  an  amount  as  will  not  be  sufficient  to  pay  the 
validated  bonds  and  interest.  One  cannot  read  the  municipal  bond  cases  in  the 
United  States  Supreme  Court  reports  of  the  seventies  and  eighties  without 
being  impressed  with  the  belief  that  the  legality  of  bonds  is  of  less  importance 
than  the  power  of  taxation  behind  them." 

651.  It  is  fortunate  indeed,  not  only  for  investors  in  American 
municipals,  but  for  our  cities,  that  courts,  both  state  and  federal, 
but  particularly  federal,  have  taken  the  stand  that  repudiation 
shall  not  be  generally  permissible  on  grounds  of  mere  technicality; 
for  otherwise  the  status  of  municipal  credit  would  not  be  on  its 
present  high  plane. 

652.  A  democratic  form  of  government  must  necessarily  be  de- 
ficient in  some  excellences  that  pertain  to  the  rule  of  an  aristoc- 
racy of  inheritance.  Among  them  is  the  peculiar  training  for  petty 
government  that  a  system  of  rotation  in  office  achieves.  Municipal 
officers,  raised  to  position  without  special  fitness,  and  with  tenure 
subject  to  the  vicissitudes  of  politics,  are  not  the  best  sort  of 
persons  in  whose  hands  to  leave  the  power  to  borrow  large  sums  of 
money  in  exact  conformity  with  a  complex  body  of  laws. 

653.  A  record  of  sales,  during  1907,  of  the  more  important  com- 
munities in  the  United  States  shows  that  of  a  total  of  about 
$200,000,000  of  municipal  and  state  bonds  issued,  some  $4,000,000, 
or  2  per  cent.,  divided  among  G5  municipal  issues,  were  finally  de- 
clined by  those  who  had  bought  them  subject  to  the  approval  of 
their  attorneys ;  and  usually,  but  not  always,  declined  on  the  ground 
that  the  issue  was  invalid  because  of  some  lack  of  compliance  with 
minor  requirements  of  law.  This  $4,000,000,  of  course,  does  not 
take  into  account  a  very  much  larger  amount  of  issues  which  the 
attorney  of  the  purchaser  found  insufficiently  protected  by  law, 
but  which  by  further  acts  at  his  suggestion  the  issuing  community 
was  able  completely  to  validate  without  formal  resale.  There  is  not 
the  slightest  suspicion  of  bad  faith  to  be  attached  to  these  com- 
munities that  had  issues  rejected;  but  there  is  a  very  significant 
moral  to  be  drawn  from  the  inference  of  gross  carelessness. 

654.  The  Causes  of  Illegality.  The  causes  of  illegality  are  legion ; 
and  it  would  not  be  practicable,  or  possible,  to  mention  them  all 
here.  In  their  minutia?,  they  concern  only  the  courts,  the  mu- 
nicipality,  and  the  bond  attorney.     Analyzed,   however,   they  re- 


CITY  AND  TOWN  BONDS :  VALIDITY  AND  GOOD  FAITH    227 

solve  themselves  into  four  groups:  they  have  to  do  with,  1,  the 
authority  of  issue :  2,  the  purpose  of  issue:  3.  the  process  of  issue; 
4,  the  violation  of  debt,  and  tax  restrictions. 

655.  The  ultimate  authority  to  issue  municipal  bonds  is  in  con- 
stitution or  statutes;  really  it  resides  in  the  legislature.  Con- 
stitutional provisions  are  very  accessible,  but  the  statutes  have  to 
be  studied  very  thoroughly  throughout  if  one  seeks  information  as 
to  legality  at  first  hand,  for  one  never  can  tell  in  what  obscure 
place  may  be  hidden  an  act  that  may  have  effect.  Moreover,  the 
statutes  are  sometimes  susceptible  of  misinterpretation.  So  in 
the  matter  of  the  authority  of  issue,  for  illustration,  prominent 
firms  of  bond  attorneys  are  at  variance  as  to  the  necessity  of 
specific  legislative  sanction,  when  municipalities  in  Maine  issue 
bonds. 

656.  In  addition  to  authorization  by  legislature,  that  by  popu- 
lar vote  is  required  for  all  issues  in  many  states,  and  for  certain 
issues  or  kinds  of  issues,  and  for  certain  kinds  of  municipalities 
(such  as  towns  and  taxing  districts),  in  other  states.  Irregulari- 
ties in  balloting  may  invalidate  this  authorization  by  election,  as 
recently  in  Asbury  Park,  New  Jersey,  and  Dawson,  Minnesota. 
Special  legislation  giving  a  municipality  or  a  group  of  them,  but 
not  all  municipalities  of  the  class,  authority  to  incur  debts  for  a 
certain  purpose,  has  for  the  past  20  years  been  on  the  decline, 
owing  to  the  growth  of  constitutional  prohibitions.  The  constitu- 
tions quite  generally  forbid  legislatures  to  pass  local  laws  when,  in 
the  opinion  of  the  legislatures,  general  laws  are  adequate.  One 
treads  on  dangerous  ground  who  buys  municipal  bonds  issued  under 
authority  of  laws  that  are  general  in  their  form  but  clearly  special 
in  their  application ;  for  the  courts  do  not  agree  as  to  the  legality  of 
such  legislation. 

657.  Invalidity  more  often  arises  from  minor  errors  connected 
with  the  process  of  issue.  Advertisement  may  have  been  omitted, 
or  may  have  been  insufficient.  Flotations  of  Philadelphia,  New 
York,  and  Plainfield,  New  Jersey,  have  been  declined  lately  on  the 
score  of  insufficient  advertisement;  of  Peru,  Indiana,  and  Beading, 
Ohio,  because  of  errors  in  the  details.  It  seems  hardly  possible 
that  a  municipality  could  mistake  a  law  so  apparently  simple  and 
general  as  that  requiring  the  price  to  be  at  par  or  above;  but  Ma- 
trona  County,  Wyoming,  sold  an  issue  of  4s  at  par  without  includ- 
ing accrued  interest,  and  a  resale  some  months  later  was  required 
for  validation.    Oneonta,  New  York,  committed  an  equally  incom- 


228     CITY  AND  TOWN  BONDS :  VALIDITY  AND  GOOD  FAITH 

prehensible  blunder  four  years  ago  in  soiling  an  issue  bearing  an 
interest  rate  in  excess  of  what  was  legal.  The  bonds  were  issued 
as  4£s,  but  the  village  was  not  allowed  to  sell  anything  higher 
than  4s ;  and  the  bonds  had  to  be  remade  and  sold  as  4s.  A  school 
district  of  North  Hempstead,  Long  Island,  recently  had  a  large 
issue  refused  because  the  resolution  failed  to  state  the  rate  of  in- 
terest, or  the  maturity  of  the  bonds.  An  excellent  illustration  of 
the  nice  regard  for  detail  necessary  in  the  process  of  municipal  bond 
issue,  comes  from  Boston.  A  few  years  ago  the  Council  of  that 
city  voted  certain  appropriations  to  be  met  by  a  bond  issue.  A 
rumor  was  circulated  to  the  effect  that  one  member  of  the  Council 
had  left  the  meeting  before  the  vote  was  taken.  A  denial  was  im- 
mediately forthcoming.  But  since  the  vote  had  been  close  the 
mayor  called  for  a  repassage  of  the  ordinance,  in  order  not  to 
prejudice  the  bidding  for  that  issue. 

658.  An  important  detail  not  to  be  overlooked  is  that  the  special 
tax  levy  be  voted  if  required  by  law,  or  if  permissible  and  to  be 
expected,  although  not  specifically  mentioned  in  the  bond  enabling 
act.  And  if  there  are  any  restrictions  to  the  power  of  taxation, 
it  is  equally  important  that  the  margin  between  the  tax  rate  neces- 
sary for  the  funded  debt  and  the  rate  allowed  by  law  be  amply 
sufficient  to  allow  for  any  reasonable  charge  for  current  expenses 
of  the  municipality,  which  have  priority  of  payment. 

659.  The  purpose  of  issue  has  played  no  inconsiderable  part  in 
matters  of  legality  and  therefore  in  the  history  of  past  default 
and  repudiation.  It  is  still  a  factor  worth  thought  in  its  relation 
to  legality.  To  mention  railroad  aid  bonds  is  still  lo  wave  a  red 
flag  in  many  sections  of  the  country,  especially  in  the  Middle 
West.  Of  the  300  municipalities  in  Illinois  that  issued  railroad 
aid  bonds  in  the  old  days,  over  one-third  repudiated  them.  Yet 
it  is  statutory  rather  than  common  law  (except  in  Michigan)  that 
is  generally  hostile.  There  are  still,  however,  many  states  which 
specifically  or  inferentially  permit  the  issuance  of  railroad  aid 
bonds;  for  steam  transportation  service  is  commonly  recognized 
as  a  public  function. 

660.  But  it  is  in  furtherance  only  of  public  enterprises  that 
municipal  corporations  may  enter  into  contracts  and  create  obli- 
gations. Even  statutory  authority  may  not  transcend  this  limi- 
tation. And  the  purpose  of  issue  must  not  only  be  public;  it  must 
also  be  in  keeping  with  the  political  functions  of  the  obligor 
corporation.     Since  the  social  and  political  demands  of  cities  and 


CITY  AND  TOWN  BONDS :  VALIDITY  AND  GOOD  FAITH    22J) 

towns  are  more  varied  than  those  of  counties  and  taxing  districts, 
and  since  their  corporate  existence  approaches  more  nearly  to  inde- 
pendence, it  follows  that  there  are  more  legitimate  purposes  for 
which  cities  and  towns  may  issue  bonds. 

661.  It  will  be  found  that  about  two-thirds  of  all  flotations  are 
for  five  purposes; — for  waterworks,  sewers  and  drainage,  schools 
and  school  buildings,  streets  and  bridges,  and  public  works,  gen- 
erally. Although  this  may  not  be  quite  the  order  of  importance 
gauged  by  the  amount  borrowed,  it  is  the  order  of  importance 
from  the  standpoint  of  social  welfare.  Before  Indian  Territory 
became  a  state,  it  was  for  only  the  first  three  purposes  that  Con- 
gress, by  act  of  1902,  permitted  municipalities  in  the  Territory 
to    obligate    themselves. 

662.  It  would  be  idle  to  attempt  a  list  of  the  purposes  for 
which  municipalities  may  incur  debt;  but  it  may  be  worth  while 
to  emphasize  again  the  fact  that,  apart  from  all  questions  of  legal- 
ity, some  purposes  are  more  legitimate  than  others.  No  one  would 
question  the  propriety  of  housing  fire  apparatus  with  the  proceeds 
of  a  city  loan,  but  many  would  deprecate  the  use  of  a  city's 
credit  to  plot  a  cemetery  or  build  a  Grand  Army  Hall.  If  rarely, 
yet  at  least  sometimes,  the  distinction  between  legality  and  legiti- 
macy of  purpose  has  had  a  very  practical  bearing  upon  bond  se- 
curity. During  the  days  of  Reconstruction,  while  local  Unionists 
and  Northern  Republicans  were  running  the  finances  of  Louisiana 
with  a  lavish  hand,  the  Democrats  of  New  Orleans,  upon  whom, 
as  taxpayers,  the  burden  principally  fell,  made  it  known  through 
the  press  and  by  public  resolves,  that  when  they  came  into  power 
again  the  state  would  repudiate  such  bonds  as  were  not  issued 
against  legitimate  wants  of  the  state.     And  they  kept  their  word. 

663.  The  demand  in  some  quarters  for  municipal  ownership 
and  operation  of  public  utilities  raises  the  question  to  what  ex- 
tent supplying  a  community  with  water  and  supplying  it  with 
light  are  public  functions.  It  is  a  question  that  each  state  gov- 
ernment has  to  answer  through  its  legislative  and  judicial 
branches.  It  will  pass  without  challenge,  however,  that  none  but 
municipal  corporations  proper, — those  the  subject  of  this  chapter, 
— will  undertake  the  ownership  of  public  utilities,  such  as  gas 
and    electric   lighting. 

664.  If  the  purpose  of  an  issue,  which  is  generally  denoted  by 
its  title,  is  to  take  care  of  a  previous  flotation,  a  study  of  the  ante- 
cedent issue  is  highly  desirable.     At  best,  "  Refunding,"  or  "  Re- 


230     CITY  AND  TOWN  BONDS  :   VALIDITY  AND  GOOD  FAITH 

newal  Bonds,"  comprising  about  10  per  cent,  of  all  permanei>; 
loans,  indicate  the  extension  of  a  loan  that  the  municipality  felt  it 
could  not  pay  conveniently.  At  worst  they  indicate  a  plot  to 
float  a  loan  under  a  misleading  title,  which  might  or  would  prove 
illegal  if  sold  directly,  without  refunding.  The  legality  of  Re- 
funding Bonds,  then,  involves  its  own  issue,  and  the  issue  it  re- 
funds. 

665.  "  Current  Expense  "  and  "  Deficiency  "  loans  betray  a  form 
of  accounting  improper  everywhere,  and  illegal  in  some  states. 
"  Compromise "  and  "  Adjustment  Bonds "  are  the  after-growth 
of  default  and  litigation.  Securities  with  titles  like  these  indicate 
equivocal  financing.  Without  investigation  let  no  such  bonds  be 
trusted. 

666.  Validity,  as  affected  by  debt  restrictions,  gives  constant 
concern  to  bond  attorneys.  The  law  is  generally  explicit  enough, 
and  sometimes  the  penalty  too.  The  Constitution  of  Indiana  says : 
"all  bonds  or  obligations  in  excess  of  such  amount"  (permitted 
by  law,  namely  2  per  cent,  of  the  assessment)  "  shall  be  void." 
The  difficulty  is  that  there  may  often  be  disagreement  as  to  the 
classification  of  debts,  especially  in  cities,  so  that  the  net  debt, 
upon  which  the  restriction  is  based,  may  be  in  dispute.  The  diffi- 
culties sometimes  to  be  encountered  in  ascertaining  these  statistical 
matters,  have  been  canvassed  at  length  in  previous  pages. 

667.  Although  in  the  United  States  there  is  little  recognized 
relationship  between  the  life  of  a  loan  and  the  purpose  of  its  crea- 
tion, there  are  occasional  statutory  limitations  of  life  based  upon 
the  principle  that  a  debt  should  be  extinguished  before  the  object 
for  which  it  was  incurred  shall  have  ceased  its  usefulness.  To  this 
end  some  states  do  not  allow  street  improvement  or  school  bonds 
to  run  as  long  as  water  bonds.  Again  in  this  matter  we  may  look 
for  example  to  Canada,  where  bonds  issued  for  public  improve- 
ments, such  as  sidewalks,  etc.,  may  not  exceed  in  term  the  prob- 
able life  of  the  improvement;  and  they  may  not  be  refunded;  and 
an  engineer's  certificate,  stating  this  probable  life,  is  a  necessary 
preliminary  to  the  passing  of  the  debt  by-law.  But  in  New  York, 
50-year  bonds  may  be  used  for  paving  Broadway,  that  our  children 
may  pay  for  work  which  perished  before  their  birth.  The  principle 
of  limited  duration  finds  its  most  perfect  expression  in  10-year 
serial  equipment  bonds,  but  the  extension  of  the  principle  to  many 
industrial  bond  issues,  especially  those  secured  by  mortgage  on 
wealth  like  lumber  and  minerals  which  is  being  depleted  by  opera- 


CITY  AND  TOWN  BONDS :  VALIDITY  AND  GOOD  FAITH    231 

tion,  lias  been  very  successful,  and  its  growing  vogue  is  one  of 
the  most  gratifying  financial  developments  of  recent  years.  Our 
municipal  lawmaking  bodies  might  well  give  heed. 


Remedies  of  Invalidity 

668.  Invalidity,  as  affected  by  the  authority,  purpose,  or  process 
of  issue,  or  by  the  violation  of  debt  or  tax  restrictions,  is  almost 
always  accidental.  There  is  seldom  any  deliberate  irregularity  on 
the  part  of  the  municipality,  except  in  the  petty  matter  of  award- 
ing loans.  Criminality  on  the  part  of  outsiders,  however,  is  by  no 
means  obsolete.  In  recent  years  the  forgery  and  successful 
hypothecation  of  municipal  bonds  by  two  men,  alone,  has  amounted 
to  11,600,000. 

669.  Trust  Company  Supervision  and  Certification.  Therefore  to 
safeguard  the  community  and  the  investor  against  forgery  and 
overissue  there  has  arisen  in  the  past  decade  the  custom  of  placing 
the  supervision  of  new  municipal  issues  in  the  hands  of  trust  com- 
panies. Following  the  regulations  of  the  leading  stock  exchanges, 
the  trust  companies  furnish  steel  engraving  of  highest  quality, 
and  sometimes  special  paper.  Upon  each  bond  is  placed  their 
countersignature.  Often  before  the  issue  is  offered  the  bankers 
or  the  public,  bond  attorneys  acting  for  the  trust  company  pass 
upon  its  legality.  In  these  ways  every  precaution  is  taken  against 
invalidity;  and  possible  loss,  except  through  municipal  bankruptcy, 
is  reduced  to  a  minimum. 

670.  State  Certification  of  Validity.  Another  encouraging  sign  in 
the  development  of  bond  finance  is  the  growth  of  constitutional  and 
statutory  measures  to  protect  municipal  loans  from  future  charges 
of  illegal  issuance.  By  the  constitution  of  1889  North  Dakota 
declared 

"  No  bond  or  evidence  of  indebtedness  of  the  state  shall  be  valid  unless  the 
same  shall  have  indorsed  thereon  a  certificate  signed  by  the  Auditor  and  Secre- 
tary of  State,  showing  that  the  bond  or  evidence  of  debt  is  issued  pursuant 
to  law  and  is  within  the  debt  limit.  No  bond  or  evidence  of  debt  of  any  county, 
or  bond  of  any  township  or  other  political  subdivision,  shall  be  valid  unless  the 
same  shall  have  indorsed  thereon  a  certificate,  signed  by  the  county  auditor,  or 
other  officer  authorized  by  law  to  sign  such  certificate,  stating  that  said  bond 
or  evidence  of  debt  is  issued  pursuant  to  law  and  is  within  the  debt  limit." 

671.  In  1893  Texas  passed  a  state  law  requiring  the  certification 
and  registration  of  all  municipal  loans.    It  will  be  observed  that  in 


2.".2     ( '  IT  V  AM)  TOWN  VA  )NDS  :  VALIDITY  AND  GOOD  FAITH 

Beveral  respects  this  is  an  improvement  on  the  provision  of  North 
Dakota. 

"...  Hereafter  a  county,  city  or  town,  .  .  .  before  .  .  .  bonds  are  offered 
for  sale,  shall  Forward  to  the  Attorney-General  the  bonds  to  be  issued,  a  cer- 
tified copy  of  the  order  or  ordinance  levying  the  tax  to  pay  interest  and  provide 
:i  sinking  fund,  with  a  statement  of  the  total  bonded  indebtedness  .  .  .  includ- 
ing the  series  of  bonds  proposed,  and  the  assessed  value  of  the  property  for 
purposes  of  taxation  ...;...  and  if  the  Attorney-General  shall  find  that 
such  bonds  are  issued  in  conformity  to  the  Constitution  and  laws,  and  that  they 
are  valid  and  binding  obligations   ...   he  shall  so  officially  certify. 

"...  Such  bonds,  after  receiving  the  certificate  of  the  Attorney-General, 
and  having  been  registered  in  the  Comptroller's  office,  as  provided  herein,  shall 
thereafter  be  held,  in  every  action,  suit  or  proceeding  in  which  their  validity 
is  or  may  be  brought  into  question,  prima  facie  valid  and  binding  obliga- 
tions .  .  .  :  provided  the  only  defense  which  can  be  offered  against  the  validity 
of  said  bonds  shall  be  fraud  or  forgery." 

672.  In  1897  Georgia  passed  a  state  law  to  similar  effect.  When 
a  municipal  loan  in  that  state  shall  have  been  voted,  the  Solicitor- 
General,  or  Attorney-General,  shall  file  a  petition  in  the  office  of  the 
clerk  of  the  Superior  Court  setting  forth  the  details  of  the  issue. 
The  Judge  of  the  Court  shall  hear  and  determine  all  questions  of 
law  and  of  fact.  If  no  bill  of  exceptions  is  filed  within  20  days, 
or  if  the  Supreme  Court  affirms  the  judgment  of  the  Superior 
Court  when  contested,  the  judgment  of  the  Superior  Court  "  shall 
be  forever  conclusive  upon  the  validity  of  said  bonds  against  the 
said  county,  municipality,  or  division,  and  the  validity  of  said  bonds 
shall  never  be  called  in  question  in  any  court  of  this  state."  All 
bonds  so  passed  upon  shall  have  stamped  or  written  on  them, 
"  validated  and  confirmed  by  judgment  of  the  Superior  Court." 

673.  Tn  1002,  New  Jersey  passed  a  new  School  Law  and  took 
occasion  to  validate  all  subsequent  school  issues;  but  this  law  has 
no  bearing  upon  other  municipal  loans  in  that  state.  Its  text  is  as 
follows : 

"Whenever  bonds  shall  be  authorized  to  be  issued  by  any  school  district  as 
aforesaid,  the  district  clerk  shall  transmit  certified  copies  of  the  record  of  the 
proceedings  authorizing  the  issuing  of  such  bonds  to  the  Attorney-General  for 
his  approval  of  the  legality  of  said  proceedings,  and  duplicate  copies  of  such 
record  shall  be  filed  with  the  State  Superintendent  of  Public  Instruction." 

674.  When  the  new  State  of  Oklahoma  was  formed  in  1907,  a 
clause  validating  all  state  and  municipal  loans  was  inserted.  The 
text  is  almost  identical  with  that  of  its  model,  the  clause  in  North 
Dakota's  constitution. 


CITY  AND  TOWN  BONDS :  VALIDITY  AND  GOOD  FAITH    233 

675.  With  Kansas,  these  are  the  only  states  we  recall  that  di- 
rectly or  indirectly  certify  by  the  state  to  the  validity  of  municipal 
bonds  as  a  class.  Still  it  is  to  be  seen  that,  slowly  but  steadily,  our 
lawmakers  are  protecting  investors  against  the  possibility  of 
illegality. 

676.  Again  turning  to  Canada  for  suggestions: — the  Ontario 
municipal  act  limits  the  time  within  which  action  may  be  taken 
to  quash  by-laws  purporting  to  authorize  bond  issues.  But  it 
further  provides  that  if  interest  or  any  principal  which  may  have 
become  due  shall  have  been  paid  for  one  year  the  bonds  must  be 
held  valid. 

Such  a  validating  clause  is  not  so  good,  however,  as  the  North 
Dakota  provision,  which  in  its  effect  is  like  a  mandatory  Torrens  Act 
guaranteeing  title  to  land.  Similar  provisions  are  found  also  in 
the  municipal  acts  of  other  Canadian  provinces.  Alberta,  and  if 
we  remember  rightly,  Saskatchewan,  has  a  statutory  provision 
with  regard  to  school  district  bonds  which  is  almost  identical 
with  the  North  Dakota  provision. 

677.  Validation  of  Issues  by  Courts  and  legislatures.  Although 
these  ounces  of  prevention  are  worth  more  than  the  proverbial  pound 
of  cure,  yet  there  is  much  assurance  to  be  got  from  knowing  that 
because  the  legality  of  a  loan  is  in  question  it  will  not  necessarily 
be  defaulted.  The  city  of  Santa  Cruz,  California,  has  outstanding 
water  bonds  which,  in  the  opinion  of  many,  are  illegal;  but  for- 
tunately the  taxpayers  are  unable  to  get  satisfaction  from  the  courts. 
In  1907  Walla  Walla,  Washington,  and  Christian  County,  Kentucky, 
sold  issues  which  were  declined,  and  Seattle  an  issue  which  was 
twice  declined  because  of  questionable  validity.  By  upholding  the 
validity  of  these  issues  the  Supreme  Courts  of  the  two  states  made 
possible  the  sale  of  the  bonds.  With  the  same  object  in  view  an 
issue  of  Custer  County,  Montana,  declined  in  1906,  was  subsequently 
validated  by  legislative  acts. 

678.  Still  another  means  lies  open,  and  sometimes  has  been 
availed  of,  to  safeguard  investors  from  illegal  issues,  and  that  is 
the  employment  by  a  municipality  of  some  authoritative  firm  of  bond 
attorneys  to  oversee  the  preparation  of  the  enabling  act  and  the 
subsequent  proceedings.  Thus  the  water  bonds  of  Tucson,  Ari- 
zona, were  issued  pursuant  to  an  act  of  Congress,  and  to  an 
ordinance  of  the  City  Council;  and  both  the  act  and  the 
ordinance  were  drafted  by  one  of  the  leading  legal  firms  of  the 
country. 


234     CITY  AND  TOWN  BONDS  :  VALIDITY  AND  GOOD  FAITH 

679.  Estoppel  and  the  Bond  Recital.  Lastly,  and  in  some  respects 
most  important  of  all,  validity  is  safeguarded  by  the  recital  en- 
graved upon  the  bond  itself.  Municipal  bond  recitals  in  the  United 
States  have  conformed  of  late  to  certain  patterns,  all  more  or  less 
closely  following  the  phraseology  held  to  be  effective  by  the  United 
States  Supreme  Court.  The  New  Hampshire  municipal  bond  act 
of  1895  contains  sets  of  forms  acceptable  to  the  state.  The  bond 
may  or  may  not  declare  that  it  is  one  of  a  series  of  a  certain  num- 
ber, or  mention  the  specific  purpose  of  issue,  or  the  particular  statute 
under  which  it  is  authorized.  But  besides  promising  to  pay  the 
bearer  or  the  registered  owner  the  principal  amount  at  a  certain 
time  and  place,  it  should  declare  in  broad  and  general  terms  that 
it  is  issued  under  authority  of  law,  for  a  corporate  purpose ;  that  all 
things  necessary  have  been  done  to  make  it  a  legal,  binding,  and 
valid  obligation  of  the  municipality;  that  the  indebtedness  of  the 


municipality,  including  the  issue  of  which  it  is  one,  does  not  exceed 
the  limit  established  by  law;  and  that  the  tax  necessary  to  pay  it 
does  not  exceed  any  limitation  established  by  law. 
~680.  The  courts  have  usually  held  that  the  recital  of  regularity, 
of  which  the  above  is  an  outline,  "estops"  (bars)  the  municipality 
from  pleading  invalidity  as  against  an  innocent  holder  of  its  bonds 
for  value. 

681.  The  Bond  Attorney.  Enough  has  been  said  in  this  and  pre- 
vious chapters  to  indicate  the  exceedingly  important  service  ren- 
dered by  the  bond  attorney.  One  of  the  strongest  influences  making 
for  the  present  admirable  credit  of  American  municipalities  has 
been  the  scrupulous  care  with  which  all  questions  affecting  legality 
have  been  considered.  To  attempt  an  estimate  of  the  proportion  of 
all  loans  that  bave  been  put  out  with  sufficient  irregularity  to  cause 
correction  by  attorneys  before  acceptance  would  occasion  unneces- 
sary alarm.  The  bond  attorney  stands  between  the  taxpayer  and 
the  investor,  protecting  each  against  the  other,  and  working  in  the 
interest  of  both  for  a  still  higher  development  of  municipal  bond  law 
and  bond  practice.  His  work  is  now  so  well  done,  and  so  systemati- 
cally, that  we  rightly  take  it  as  a  matter  of  course,  and  give  our- 
selves, as  individual  buyers,  in  dealing  with  bond  issues  of 
recent  years,  to  other  considerations  than  those  connected  with 
validity. 

682.  Good  Faith.  It  may  seem  to  those  who  are  not  familiar  with 
the  history  of  municipal  credit  that  good  faith  is  so  bound  up  with 
the  legal  aspects  of  funded  loans  that  it  is  hardly  a  topic  for  in- 


CITY  AND  TOWN  BONDS :  VALIDITY  AND  GOOD  FAITH    235 

dependent  treatment.  But  this  is  not  the  case.  Although  prosperity 
is  the  best  guaranty  of  debt-payment,  and  law  an  able  second,  and 
good  faith  easily  influenced  by  both  prosperity  and  legality,  yet  it 
is  a  thing  apart,  and  may  and  does  exist,  and  support  the  credit 
of  loans  which  are  backed  by  neither  of  the  other  two. 

683.  San  Francisco  has  now  recovered  from  a  calamity  that  al- 
most obliterated  her.  The  city's  extreme  necessities  have  been  the 
occasion  of  heavy  bond  issues.  Yet  the  price  paid  for  these  has 
suffered  little  from  the  fact  of  the  earthquake  and  the  subsequent 
prostration.  Of  course  investors  are  ready  to  buy  the  obligations 
of  San  Francisco  because  they  have  confidence  in  her  material 
future ;  but  this  confidence  is  greatly  strengthened  by  the  fact  that 
the  city  never  repudiated  any  of  its  obligations. 

684.  On  the  other  hand  bad  faith  may  exist  where  there  can 
be  no  question  of  either  financial  competency  or  validity.  Poni- 
eroy,  Ohio,  deliberately  defaulted  in  1910,  on  the  interest  of  its 
largest  issue  of  Refunding  6s.  The  reason  ascribed  was  that  the 
bonds  were  not  callable;  but  the  village  fathers  felt  they  would 
like  to  retire  the  bonds  and  took  this  means  of  accomplishing  their 
purpose.  Although  Pomeroy  may  hope  to  lower  its  interest  rateif 
the  breach  of  faith  will  cost  more  than  it  comes  to,  for  it  removes' 
the  bonds  of  the  village  from  the  class  that  are  legal  for  investment) 
by  savings  banks. 

685.  The  factor  of  municipal  credit  that  we  entitle  Good  Faith 
has  kept  pace  in  growth  with  the  factors  Financial  Competency 
and  Validity.  Only  30  years  ago,  approximately,  there  was  held 
in  Missouri  a  general  convention  of  representatives  from  various 
parts  of  the  state  for  the  purpose  of  seeking  ways  and  means  for 
municipal  bond  repudiation.  The  following  extract  from  an 
address  delivered  there  and  afterwards  circulated,  expresses 
the  contemporary  opinion  of  the  Middle  West  upon  all  three 
topics. 

"  Many  labored  efforts  have  been  made  to  show  that  there  are  questions  of 
good  faith  and  moral  obligation  in  reference  to  the  payment  of  these  bonds, 
wholly  independent  of  the  question  of  their  legality.  We  maintain  that  argu- 
ments based  on  such  considerations  have  no  application  to  the  payment  of 
municipal  obligations,  and  never  had.  .  .  .  The  only  questions  to  be  asked 
and  answered  in  reference  to  a  bond  of  that  character  are,  Has  it  been  issued 
by  proper  authority  of  law?  Is  the  taxable  property  of  the  locality  sufficient 
to  meet  the  obligation,  if  its  payment  has  to  be  enforced  by  law?  These  are 
the  true  foundations  of  public  credit  as  applied  to  municipal  corporations,  and 
they  are  matters  of  law  purely." 


23G     CITY  AND  TOWN  BONDS  :  VALIDITY  AND  GOOD  FAITH 

686.  What  are  the  inevitable  concomitants  and  results  of  such 
reasoning?  Repudiation.  Default  and  repudiation.  So  it  is  that 
the  Mississippi  Valley  at  this  period  gives  up  a  long  list  of  defaulting 
cities,  among  which  are  the  following:  Duluth,  Minnesota;  Keokuk 
and  McGregor,  Iowa;  Quincy  and  Cairo,  Illinois;  St.  Joseph  and 
Cape  Girardeau,  Missouri;  Leavenworth,  Lawrence,  and  Topeka, 
Kansas;  Nehraska  City,  Nebraska;  Little  Rock  and  Helena,  Arkan- 
sas; Memphis,  Tennessee;  Shreveport  and  New  Orleans,  Louisiana; 
Mobile,  Alabama;  and  Houston,  Texas.  Missouri,  naturally,  after 
such  an  expression  of  sophistry,  was  not  to  be  outdone.  "  Of  one 
hundred  counties,  townships,  and  cities  issuing  bonds  in  Missouri, 
nine-tenths  have  defaulted."  1 

687.  How  sentiment  has  changed  within  a  generation  we  already 
know  from  our  survey  of  the  many  stringent  laws  regulating  the 
amount  and  manner  of  debt-incurrence,  and  from  the  attitude  of 
the  courts  towards  the  rights  of  innocent  purchasers.  Instead  of 
unblushing  and  deliberate  repudiation  on  the  part  of  municipalities 
that  are  now  in  difficulties  of  one  sort  or  another,  we  find  a  sober 
acknowledgment  of  the  moral  obligation.  Helena,  Montana,  stands 
ready  to  retire  her  illegal  warrants  of  '93  when  a  way  shall  be 
found.  Jeffersonville,  Indiana,  has  long  since  refunded  an  illegal 
issue,  with  the  permission  of  the  legislature.  Even  when  com- 
promise with  the  bondholders  shall  become  necessary,  through 
visitation  of  catastrophe:  war,  pestilence,  earthquake,  fire,  flood,  or 
wind-storm, — actus  dei,  acts  of  God,  is  the  legal  phrase, — we  shall 
be  led  to  expect  hereafter,  from  our  experiences  with  Austin  and 
Galveston,  Texas,  and  other  cities,  that  any  adjustments  necessary 
will  be  equitable,  and  that  the  municipality  will  go  more  than 
halfway  in  meeting  its  creditors  to  maintain  its  good  faith.  If 
the  present  is  any  criterion,  we  shall  never  again  see  a  city  of  the 
size  of  Memphis,  Tennessee,  or  Duluth,  Minnesota,  disincorporate 
itself  with  the  connivance  of  courts  or  legislatures  in  the  attempt 
to  defraud  its  creditors. 

688.  Finally,  there  can  be  no  greater  assurance  of  good  faith 
given  investors  in  municipal  bonds  than  the  simple  statement  (for 
which  we  have  authoritative  support)  that  no  American  munici- 
pality of  any  importance  has  defaulted  in  recent  years  on  the  prin- 
cipal  or  interest  of  any  of  its  obligations.2 


1  North  American  Review,  August,  1884. 

8  In  the  italicized  lines  emphasize  the  word  "importance. 


CITY  AND  TOWN  BONDS :  VALIDITY  AND  GOOD  FAITH    237 

Other  Matters  Affecting  Municipal  Credit 

689.  The  credit  of  a  city  or  town  is  in  no  way  different  from 
that  of  a  firm  or  individual.  It  is  based  on  records  and  figures, 
but  it  is  not  ascertainable  by  means  of  them.  Municipal  credit  is 
the  composite  judgment  of  bond  buyers  as  to  the  certainty  and 
promptness  with  which  payments  due  shall  be  met.  It  might  be 
difficult  to  explain  convincingly  why  Providence,  Hartford,  Spring- 
field, and  Worcester  are  close  rival  claimants  for  the  honor  of 
highest  credit  in  New  England;  or  why  the  credit  of  Albany  is 
slightly  better  than  that  of  Buffalo ;  or  the  credit  of  corrupt  Philadel- 
phia almost  equal  to  any  of  the  cities  mentioned.  It  is  not,  how- 
ever, difficult  to  understand,  from  the  principles  laid  down  in  these 
pages,  why  the  credit  of  municipalities  in  Massachusetts,  Connecti- 
cut, and  New  York  is  better  than  the  credit  of  those  in  Louisiana, 
Kansas,  and  Nevada 

690.  Yet  we  have  by  no  means  canvassed  all  the  influences  that 
affect  the  security  for  city  and  town  bonds.  The  volume  of  indus- 
try and  commerce,  as  distinct  from  population  and  taxable  wealth, 
gives  up  pertinent  figures.  They  are  to  be  found  in  the  statement 
of  bank  deposits,  capital,  surplus,  and  clearings,  jmthin  statistics 
of  building,  employment,  and  wages, — some  of  which  are,  or  will  be, 
furnished  by  a  bond  house  offering  a  municipal  loan.  "  One  in- 
dustry "  towns  like  Marblehead  and  Brockton,  Massachusetts,  West 
Seneca,  New  York,  Houghton,  Michigan,  and  Butte,  Montana,  suf- 
fer in  credit  from  the  undistributed  risk.  The  town  of  Gillette, 
Colorado,  was  dependent  for  its  existence  upon  the  life  of  the 
neighboring  mines.  These  have  failed,  and  Gillette,  with  a  popu- 
lation reduced  to  about  50  souls,  defaulted  on  its  water  bonds  in 
Mav,  1907. 

691.  Mere  age,  coupled  with  a  good  record,  is  of  great  advantage. 
It  materially  assists  the  credit  of  Dubuque  and  Des  Moines,  Iowa, 
which  are  ancient  burgs  in  comparison  with  most  cities  of  their 
size  in  the  West.  Eastern  capital  will  purchase  their  obligations 
when  it  will  not  those  of  many  younger  cities  growing  five  times  as 
rapidly, — cities  in  Oklahoma,  for  instance,  a  state  with  hardly  a 
municipal  yesterday. 

692.  The  character  of  the  population,  of  course,  is  important. 
The  matter  is  closely  akin  to  those  of  sectional  and  race  differ- 
ences. Distinctly  proletarian  cities  are  not  looked  upon  with  equal 
favor,  nor  communities  showing  socialistic  tendencies.     In  April, 


23S     CITY  AND  TOWN  BONDS :  VALIDITY  AND  GOOD  FAITH 

1907,  not  a  single  bid  was  received  for  a  large  bond  issue  of  Mil- 
waukee, Wisconsin.  The  times  were  not  favorable  for  high  prices, 
to  be  sure,  but  the  cause  assigned  was  fear  of  a  Social  Democratic 
victory  in  the  impending  local  election. 

693.  It  will  be  seen  that  there  is  no  limit  to  the  number  of  in- 
fluences affecting  municipal  credit,  or  to  the  amount  and  range  of 
study  that  can  be  given  it.  Sciences  with  Greek  polysyllabic  titles 
can  lend  genuine  aid.  The  fact  that  the  very  existence  of  some  20 
towns  in  Maine  was  threatened  this  past  year  by  forest  fires,  calls 
attention  to  the  usefulness  of  physiography.  The  experience  of 
San  Francisco,  Stockton,  and  Alameda  suggests  that  even  seismology 
is  not  without  its  service.  Climate,  situation,  and  transportation 
facilities  are  matters  of  commercial  geography.  Commercial  geog- 
raphy speaks  favorably  for  the  future  credit  of  Tacoma  and  Seattle. 
It  was  only  1G  years  ago  that  Seattle  was  marketing  its  5  per  cents. 
at  par  at  a  time  that  New  York  City  3  per  cents,  were  par  bid. 
The  gap  between  the  bond  prices  of  the  two  cities  is  already 
closed. 

694.  Price  Factors.  Although  we  have  repeatedly  said  that  price 
was  more  closely  related  to  security,  in  municipal  issues,  than  in 
any  others,  and  that  therefore  an  inexperienced  investor  could 
judge  of  his  security  by  the  return  offered  him  on  the  investment, 
the  statement  requires  modification.  There  are  several  price  factors 
besides  those  of  relative  security  and,  of  course,  current  interest 
rate. 

695.  Of  no  mean  effect  is  the  distribution  of  municipal  issues. 
Not  that  it  matters  much  whether  the  call  for  a  specific  loan  is 
particularly  general,  but  whether  the  city  or  town  offering  it  is  of 
sufficient  importance,  and  its  obligations  as  a  whole  (by  reason 
of  numbers  and  frequency  of  issue)  sufficiently  familiar  for  the  loan 
to  be  a  staple  of  the  bond  market.  Like  equipments,  loans  of  towns 
and  villages  suffer  in  price  somewhat  from  their  comparative  indi- 
vidual obscurity; — they  lack  the  competitive  demand; — but,  like 
equipments,  this  loss  is  compensated  by  the  general  excel- 
lence characteristic  of  the  municipal  bond  class  to  which  they 
belong. 

696.  Local  demand  is  a  very  important  price  factor.  Naturally 
the  call  of  every  section  for  its  own  municipals  is  strongest.  The 
principal  sectional  division  is  by  states,  for  within  the  state  laws 
and  regulations  are  fairly  uniform.  In  those  states,  therefore, 
where  the  demand  is  greater  than  the  supply, — in  other  words  in 


CITY  AND  TOWN  BONDS :  VALIDITY  AND  GOOD  FAITH    239 

the  older  and  riches  states  where  the  capital  accumulated  for  strictly 
investment  uses  is  large  as  compared  with  local  debts, — as  in  New 
Hampshire  particularly,  the  prices  obtained  discourage  alien  pur- 
chase. 

697.  Institutional  demand  is  not  always,  but  very  generally,  a 
phase  of  local  demand.  Laws  in  each  state  regulating  the  invest- 
ment of  state  and  municipal  sinking  funds,  of  trust  funds,  of  the 
surpluses  of  insurance  companies,  of  the  deposits  of  savings  banks, — 
are  naturally  most  favorable  to  the  securities  of  home  cities,  towns, 
and  districts ;  for  home  affairs  are  of  immediate  knowledge  and  sub- 
ject to  regulation. 

698.  Demand  for  Use  as  Collateral  is  another  market  factor. 
When  bonds  are  acceptable  by  the  Secretary  of  the  Treasurer  as  se- 
curity for  government  deposits,  or  in  emergency  against  additional 
circulation  of  national  bank  notes,  or  when  they  are  acceptable  by 
state  superintendents  of  banks  in  trust  for  trust  companies,  or  by 
superintendents  of  insurance  companies  to  secure  policy  holders, 
the  market  characteristics  and  prices  will  be  governed  accordingly. 
In  March,  1909,  there  was  an  excellent  instance  of  the  effect  of  in- 
stitutional demand  on  prices.  It  was  understood  that  the  law  re- 
quiring insurance  companies  which  do  business  in  Oregon  to  de- 
posit |50,000  of  Oregon  municipal  bonds  with  the  state  Insurance 
Commissioner,  has  been  revoked.  This  was  expected  to  have  such 
an  unfavorable  effect  that,  until  prices  for  Oregon  municipals  be- 
come adjusted  to  the  change,  the  buyers  of  bond  houses  were  cau- 
tioned against  the  purchase  of  Oregon  bonds  except  at  safe  con- 
cessions. 

699.  Tax  Exemption.  Tax  Exemption,  as  applied  to  municipal 
bonds,  is  the  most  important  price  factor  from  the  character  of  the 
security  and  the  prevailing  price  of  money.  It  is  a  subject  of  which 
not  even  all  the  general  aspects  are  familiar  to  the  investing  public. 
Probably  the  large  majority  of  bond  buyers  are  not  aware  that 
bonds  issued  by  territories  of  the  United  States  or  by  municipalities 
in  territories,  are  exempt  from  state  taxation,  either  by  the  state 
directly,  or  by  its  political  subdivisions,  to  the  same  extent  as  United 
States  bonds.  More  briefly:  Municipal  bonds  issued  in  territories, 
and  the  territorial  bonds  themselves,  are  exempt  from  tax  every- 
where in  the  United  States. 

700.  Owing  to  the  importance  of  the  subject,  and  the  general 
incredulousness  of  bond  buyers,  the  argument  as  presented  by  a 
prominent  firm  of  Chicago  attorneys  is  printed  here: 


240     CITY  AND  TOWN  BONDS  :  VALIDITY  AND  GOOD  FAITH 

"  It  is  the  settled  law  that  the  United  States  Government  has  no  power  under 
the  constitution  to  tax  the  property  or  revenue  of  the  states  or  their  munici- 
palities, and  likewise  and  for  the  same  reason  no  power  to  tax  the  honds  and 
interest  thereon  of  the  states  or  their  municipal  subdivisions.  Pollock  vs. 
Farmers'  Loan  &  Trust  Co.,  157  U.  S.  429,  584,  G,  601,  3. 

"The  converse  of  this  proposition  is  equally  well  established,  that  a  state 
has  no  power,  by  taxation  or  otherwise,  to  retard,  impede,  burden,  or  in  any 
manner  control  the  operation  of  a  constitutional  law  enacted  by  ('(ingress  to 
carry  into  execution  the  powers  vested  in  the  general  government.  McCulIough 
vs.  Maryland,  4  Wheat,,  316;  Osborn  vs.  Bank,  9  Wheat.,  738. 

"  The  territories  mentioned  are  political  subdivisions  of  the  United  States, 
and  their  relation  to  the  general  government  is  much  the  same  as  that  which 
counties  bear  to  the  state.     National  Bank  vs.  Yankton,  101  U.  S.   120. 

"The  Act  of  March  4,  1898,  was  passed  by  Congress  pursuant  to  its  constitu- 
tional paramount  dominion  and  control,  national  and  municipal,  over  the  ter- 
ritories; (Shively  vs.  Bowlby,  152  U.  S.  1);  and  the  municipal  corporations 
acting  thereunder  are  as  much  local  agencies  of  the  United  States  as  the  mu- 
nicipal corporations  in  a  state  are  state  agencies.  It  necessarily  follows,  there- 
fore, that  a  state  has  no  more  power  to  tax  the  bonds  under  consideration  than 
any  of  those  territories  or  the  Government  of  the  United  States  has  to  tax  the 
bonds  issued  by  state  municipal  corporations.     Grether  vs.  Wright,  75  Fed.  742." 

701.  Unfortunately  there  has  been  no  test  case  for  territorial 
bonds;  and  we  have  recourse,  therefore,  only  to  legal  opinions  such  as 
this.  The  case  of  Grether  vs.  Wright,  which  is  cited  in  the  argument 
above,  had  reference  to  the  obligations  of  the  District  of  Columbia; 
but  the  decision  rendered  by  Judge  (now  President)  Taft,  who 
presided,  was  sufficiently  broad  for  all  kinds  of  federal  agencies. 
As  the  result  of  these  and  like  cases,  the  opinion  of  bond  attorneys 
and  of  well-known  attorneys-general  has  been  almost  without  dis- 
sent,1 as  to  the  non-taxability  of  territorial  municipal  bonds. 

Territorial  municipals,  therefore,  have  an  attraction  for  pur- 
chase which  is  as  wide  as  the  country;  and  as  the  result  they  sell 
at  prices  unwarranted  by  the  comparative  security  behind  them. 

702.  It  is  now  announced  that  the  Supreme  Court  of  Minnesota 
holds  by  a  decision  of  March  10th,  1911,  that  municipal  bonds  of 
territories  are  taxable  as  part  of  the  assets  when  held  by  savings 
banks,  since  "the  tax  upon  the  surplus  is  a  property  lax  and  not  a 
tax  upon  the  franchise  to  exist  as  a  corporation." 

703.  Very  few  people  indeed  have  given  thought  to  the  corollary 
question  as  to  whether  bonds  issued  by  municipalities  in  territories 
remain  tax  exempt  when  the  territories  become  states.  Probably 
the  best  view  is  that  since  the  imposition  of  a  tax  violates  the  theory 

1  One  well-known  firm  of  Chicago  bond  attorneys  takes  exception  to  this  view. 


CITY  AND  TOWN  BONDS :  VALIDITY  AND  GOOD  FAITH    241 

that  as  agencies  of  the  Federal  Government  these  municipalities 
should  not  be  hindered  in  the  raising  of  funds,  the  tax  can  never  be 
imposed,  for  knowledge  on  the  part  of  investors  that  there  might 
later  be  a  tax,  would  lessen  the  price  the  bonds  would  bring  and 
thus  hinder  the  debt-making  power. 

704.  Although  United  States  bonds,  insular  bonds,  and  territorial 
municipal  bonds  are  the  only  kinds  tax  exempt  in  all  states,  in  at 
least  eight  states  all  the  municipals  issued  since  the  passage  of  an 
exempting  act  are  tax  free.  These  states,  with  the  dates  of  the 
respective  acts,  are: 

1893  New  Jersey,  1905  Wyoming,  1908  New  York, 

1902  California,  1906  Ohio,  1909  Michigan. 

1903  Indiana,  1908  Massachusetts, 

705.  In  New  Jersey,  Ohio,  and  New  York,  the  law  is  retroactive, 
in  the  sense  that  it  affects  the  old  issues  (and  their  prices)  as  well 
as  the  new,  but  not  retroactive  in  the  sense  that  past  taxes  can  be 
recovered. 

706.  The  purchaser  of  short  term  paper  issued  by  municipalities 
in  these  eight  states  should  read  the  law  of  tax  exemption  pretty 
carefully  in  case  his  paper  runs  over  tax  day.  Whether  in  New  York 
State,  tax  warrants,  loans  in  anticipation  of  taxes,  revenue  bonds, 
special  assessment  bonds,  etc.,  etc.,  shall  be  taxed  will  depend,  says 
the  State  Board  of  Tax  Commissioners,  on  whether  they  are  classed 
as  "  bonds  of  municipal  corporations  "  by  the  particular  county, 
town,  city,  or  village  issuing  them. 

707.  In  some  other  states,  e.g.  Pennsylvania,  it  is  the  law  that 
if  the  municipality  will  undertake  to  pay  the  state  tax,  the  bond 
then,  ipso  facto,  becomes  absolutely  tax  exempt;  and  if  the  holder 
is  domiciled  in  the  state  no  municipality  has  a  right  to  levy  a  per- 
sonal property  tax  against  him  on  account  of  such  bonds. 

708.  In  some  states  municipal  bonds  issued  for  certain  objects 
are  tax  exempt,  in  whole  or  in  part.  Bonds  issued  in  Connecticut 
in  aid  of  certain  local  railroads,  and  issues  refunding  these  railroad 
aid  bonds,  are  free  from  all  tax.  Before  the  passage  of  the  recent 
New  York  State  law,  all  municipals  in  the  state,  issued  for  refund- 
ing, enjoyed  special  tax  exemption;  and  in  general,  the  bonds  of 
New  York  City,  also,  except  for  the  state  tax, — when  there  was  one, 
— and  the  bonds  of  Buffalo,  after  June,  1906,  except  for  state  and 
county  tax.    Not  infrequently,  it  has  been  a  debatable  question,  e.g. 


I'll"     CITY  AND  TOWN  BONDS:  VALIDITY  AND  GOOD  FAITH 

in  Seattle,  as  to  the  extent,  if  any,  to  which  the  bonds  were  tax 
free. 

709.  In  the  whole  matter  of  tax  exemption  it  should  be  kept 
in  mind  that  exempting  laws  have  no  extraterritorial  effect.  Just 
as  United  States  bonds  are  liable  to  tax  by  foreign  countries  when 
held  by  their  citizens,  so  state  and  municipal  bonds,  tax  free  within 
their  own  confines,  are  liable  to  tax  within  the  confines  of  other 
states. 

710.  With  tax  exemption  we  come  to  the  end  of  the  more  im- 
portant factors  that  enter  into  the  intelligent  purchase  of  city  and 
town  bonds.  But  the  three  chapters  devoted  to  this  subject  will 
have  failed  of  their  purpose  if  the  multiplicity  of  principles  and 
illustrations  they  present  has  obscured  the  main  idea, — that  Ameri- 
can municipal  bonds  are  the  best  security  for  the  American  people 
to  buy.  That  is  to  say,  as  a  class,  they  will  probably  cause  less 
regret  to  their  purchasers  than  will  any  other  class  now  commonly 
bought  for  investment. 


CHAPTER  XIX 
THE  BONDS  OF  TAX  DISTRICTS 

711.  In  introducing  the  subject  of  City  and  Town  Bonds,  a 
distinction  was  made  between  municipal  corporations  proper,  such 
as  cities,  towns,  and  villages,  and  involuntary,  quasi-municipal 
corporations,  such  as  counties.  Counties,  townships,  and  the  other 
various  taxing  districts,  it  was  said,  were  usually  involuntary  cor- 
porations in  the  eyes  of  the  law. 

"  We  have  recognized,"  declares  the  Supreme  Court  of  North 
Carolina,  "  the  right  of  the  legislature  to  divide  counties  into  school 
districts,  fence  districts,  road  districts,  etc.,  and  to  confer  upon 
them  municipal  powers  and  duties." 

712.  As  involuntary  corporations,  agencies  merely  of  the  state, 
established  to  minister  to  local  needs,  the  character  of  the  bonded 
obligations  put  forth  is  determined  by  the  public  purpose  of  the 
corporation,  and  is  limited  to  that  purpose.  So,  for  the  most  part, 
school  districts  issue  only  school  bonds ;  irrigation  districts,  irriga- 
tion bonds ;  and  water  districts,  water  bonds,1  etc. 

713.  Exceptions  are  to  be  taken  to  the  singleness  of  the  purpose 
of  the  issue  in  respect  to  county  and  township  bonds.  We  have  found 
not  a  few  legitimate  county  functions;  and  townships  may  borrow 
money  for  the  construction  and  repair  of  roads,  bridges,  schools, 
town  halls,  poorhouses,  and  sometimes  for  railroad  aid. 

714.  Origin.  It  follows,  then,  that  there  is  no  limit  to  the  possible 
kinds  of  districts  except  the  limit  of  public  functions  for  which 
districts  may  be  formed.  There  are  fashions  in  these  matters  as  in 
everything  else.  Some  states  affect  Fire  Districts;  Maine,  in  par- 
ticular, Water  Districts;  Pennsylvania,  Poor  Districts.    What  may 

1  The  divisions  mentioned  are  not  always  strictly  taxing  districts.  "  Taxed 
Districts  "  would  be  a  more  exact  title,  e.g.  in  Michigan  the  county  tax  is  divided 
among  the  towns;  and  the  town  supervisors  levy  the  tax.  Per  contra,  in  Indi- 
ana, the  township  tax  is  levied  and  collected  by  the  county;  and  the  township 
bonds  are  issued  through  the  county  commissioners. 

It  is  only  for  want  of  better  classification  that  Special  Assessment  Bonds  are 
noticed  in  this  chapter. 

243 


244  THE  BONDS  OF  TAX  DISTRICTS 

be  the  necessity  for  Poor  Districts  it  is  hard  to  see,  especially  when 
the  divisions  are  coextensive  with  cities  or  counties.  Their  existence, 
especially  when  they  are  coextensive,  suggests  the  circumvention  of 
such  laws  as  those  limiting  the  amount  of  debt  or  tax  that  may  be 
levied  by  a  municipality.  The  town  of  "  X  "  may  wish  to  buy  a  poor 
farm,  or  more  probably,  build  a  school,  or  own  waterworks.  But 
the  town  does  not  wish  to  exhibit  its  true  debt  for  fear  of  hurting 
its  commercial  rating;  or  it  may  be  prohibited  from  further  debt 
incurrence  by  having  reached  its  debt  limit.  AN'hat,  then,  could  be 
more  beautifully  simple  than  to  incorporate  the  same  property  and 
population  into  a  Poor,  School,  or  Water  District,  as  the  case 
might  be?  Not  all  fiscal  sleight-of-hand  has  been  left  for  private 
corporations.  We  have  noticed  how  opportunities  for  this  sort  of 
thing  have  been  limited  in  North  Carolina. 

715.  Districts  that  are  corporations  coextensive  with  municipali- 
ties proper,  but  distinct  from  them,  may  exist  for  reasons  less  du- 
bious than  those  mentioned.  Then  again  Water  Districts  are  some- 
times formed  when  more  than  one  municipality  is  to  receive  the 
water.  This,  too,  is  not  necessarily  an  attempt  at  debt  conceal- 
ment, but  rather  an  apportionment  of  cost.  To  play  on  words, 
sometimes,  in  violation  of  the  Euclidean  axiom,  even  three  or  more 
corporate  bodies  occupy  the  same  space  at  the  same  time.  Council 
Bluffs,  Iowa,  the  Council  Bluffs  School  District,  and  Kane  Town- 
ship are  three  coextensive  municipalities.  Los  Angeles,  Los  Angeles 
City  School  District,  and  Los  Angeles  High  School  District  are 
also  coextensive. 

716.  Tax  Districts  often  have  their  origin  in  the  need  of  im- 
provement felt  by  a  locality  which  in  its  entirety  is  not  a  municipal 
corporation.  This  want,  in  the  nature  of  the  case,  is  territorial  in 
character,  rather  than  corporate.  For  instance,  people  living  in  a 
certain  locality  need  protection  from  the  encroachment  of  the 
neighboring  river  and  are  willing  to  pay  special  taxes  (to  be  levied 
on  only  the  property  to  be  benefited),  which  their  neighbors  on 
higher  ground  should  not  have  to  shoulder.  The  needs  of  these 
lowland  people  are  met  by  municipal  Levee  Districts;  or  if  it  is  a 
matter  of  marshland,  by  Drainage  Districts.  Thus  Levee  and  Drain- 
age Districts  may  include  only  parts  of  cities,  and  yet  extend  over 
the  boundaries  of  two  or  more  counties. 

717.  Again,  a  certain  small  town  may  covet  the  improvements  en- 
joyed by  nearby  cities,  especially  faucet  and  hydrant  advantages. 
But  the  town  may  be  so  laid  out  that  it  is  not  feasible  to  supply 


THE  BONDS  OF  TAX  DISTRICTS  245 

with  water  any  but  the  most  central  section.  Obviously  those  who 
are  not  to  benefit  by  the  proposed  installalion  of  a  water  supply 
will  vote  in  town  meeting  against  the  measure.  If  the  recalcitrants 
block  its  passage  the  inhabitants  of  the  central  portion  of  the  town 
may  form  a  Water  District  or  a  Fire  District,  to  include  only  the 
properties  to  be  supplied  with  water;  but  the  assessable  value  of  the 
district  may  be  95  per  cent,  of  the  town's  assessable  wealth. 

718.  Conversely,  installation  of  improvements  may  benefit  a  cer- 
tain section  which  includes  not  only  a  whole  municipal  corporation, 
but  the  inhabitants  of  a  large  adjacent  area  (e.g.  in  the  Port  of 
Portland,  Oregon,  by  opening  navigation  to  the  sea).  Under 
such  circumstances  it  is  equitable  that  all  the  benefited  property 
bear  its  fair  share  of  the  cost  of  the  improvements;  and  to  that 
end  this  district  may  rightly  be  incorporated  for  purposes  of 
taxation. 

719.  The  District  Statement.  It  is  evident  from  the  origin  of  tax- 
ing districts  that  the  financial  statement,  upon  the  basis  of  which 
the  bonds  are  usually  bought,  is  more  generally  misleading  than  the 
statement  of  counties,  cities,  or  towns.  Cities  and  towns,  for  in- 
stance, may  have  and  often  do  have  no  included  subdivisions  upon 
which  there  is  a  tax  drain  not  exhibited  in  the  regular  city  tax.  But 
taxing  districts,  on  the  other  hand,  are  quite  generally  subdivisions 
of  municipalities  proper;  and,  with  few  exceptions,  subject  to  a  tax 
drain  not  exhibited  in  their  own  tax  rate,  but  indeed  several  times 
as  great.  Therefore  it  is  even  more  desirable  that  the  bond  buyer 
be  informed  as  to  the  relation  of  the  district  to  the  larger  division 
or  divisions  of  which  it  is  a  constituent,  than  in  the  case  when  he 
purchases  bonds  of  cities,  towns,  and  counties.  And  yet  in  the  bond 
circular  he  is  almost  never  so  informed. 

720.  The  District  Tax.  The  district  tax  is  generally  smaller  than 
the  general  municipal  tax  because  it  is  levied  to  support  and  acquit 
obligations  incurred  for  a  single  object  or  purpose;  whereas,  the 
general  tax  has  to  care  for  the  multifarious  needs  of  the  munici- 
pality. In  fact  the  district  tax  is  a  "  special  tax  "  in  such  a  true 
sense  of  the  word,  and  subject  to  such  special  conditions,  that  we 
may  find  civil  divisions  like  the  Greenfield  (Mass.)  Fire  District, 
with  loans  outstanding  but  no  district  tax  at  all. 

721.  Of  the  tax  rates  of  the  various  kinds  of  districts  themselves, 
that  for  School  Districts  may  legitimately  average  higher  than  the 
other  rates,  unless  (as  by  the  laws  of  Iowa)  the  same  result  is  at- 
tained by  permitting  a  heavier  debt  incurrence;  for  the  American 


246  THE  BONDS  OF  TAX  DISTRICTS 

system  of  public  instruction  is  the  most  important  and  expensive 
special  function  on  which  it  is  customary  and  desirable  to  make 
t;ixin£  districts:  and  the  tax  has  not  only  a  funded  debt  to  main- 
tain  and  amortize,  but  also  a  heavy  annual  expenditure  for  main- 
tenance of  school,  purchase  of  supplies,  and  payment  of  salaries. 
But  even  the  school  tax  is  usually  smaller  than  the  municipal  tax 
proper. 

722.  Special  Assessment  Bonds.  The  tax  power  has  an  aspect  of 
peculiar  interest  in  Special  Assessment  Bonds.  These  securities, 
quite  commonly  issued  by  cities  and  towns,  are  made  payable  by 
statute  out  of  sinking  funds  raised,  as  the  name  implies,  by  special 
assessments  upon  the  property  benefited.  In  the  past  assessment 
sinking  funds  frequently  have  been  diverted  from  their  use, — not 
only  by  arrant  peculation,  but  by  deliberate  municipal  misappro- 
priation of  the  funds.  When,  because  of  the  resulting  deficit,  the 
interest  or  principal  of  assessment  bonds  goes  unpaid,  a  vital 
question  is  raised  as  to  the  bondholders'  recourse  to  the  tax 
power. 

723.  On  default  of  Special  Assessment  Bonds  the  bondholders 
can  look  to  the  courts  for  a  supplemental  assessment  to  make  good 
the  deficiency.  But  further  than  this,  in  certain  jurisdictions  the 
implied  power  of  taxation  has  been  extended  even  to  cover  Special 
Assessment  Bonds;  and  the  bondholders  have  been  given  judgments 
against  the  offending  municipalities,  to  be  satisfied  out  of  general 
taxes,  the  courts  holding  "  that  the  grant  of  power  to  levy  special 
assessments  for  the  payment  of  bonds  was  not  exclusive,  and  that 
although  no  authority  was  given  by  the  act  in  express  terms  for  the 
levy  of  taxes  for  bonds,  the  corporate  authorities  of  the  ciiy  might 
be  compelled  to  exercise  their  general  powers  of  taxation  to  secure 
their  payment."  x 

724.  This  extreme  extension  of  the  doctrine  of  the  implied  power 
of  taxation  would  not  hold,  however,  in  most  state  courts.  The  Su- 
preme Court  of  Wisconsin,  for  example,  has  declared  that  improve- 
ment bonds  are  not  general  city  obligations.  The  Kansas  City 
(Mo.)  Park  District  Bonds  are  a  notable  illustration  of  Special 
Assessment  of  the  same  type.  Special  Assessment  Bonds  in  Iowa, 
Indiana,  and  Illinois  are  not  a  general  liability;  but  in  Michigan  and 
Kansas  they  usually  are. 

1  United  States  vs.  New  Orleans,  98  U.  S.  381 ;  United  States  vs.  Fort  Scott, 
99  U.  S.  152;  United  States  vs.  Saunders,  124  Fed.  124. 


THE  BONDS  OF  TAX  DISTRICTS  247 

725.  The  law  in  Kansas  for  cities  of  the  first  class  runs  as  follows : 

"  Whenever  the  mayor  and  council  may  cause  any  street  or  alley  .  .  .  to  be 
graded,  .  .  .  the  expense  of  which  is  chargeable  to  the  adjacent  property,  .  .  . 
they  may,  in  their  discretion,  .  .  .  issue  internal-improvement  bonds  of  the 
city,  payable  in  ten  equal  installments  of  equal  amounts  each  year,  none  of 
which  bonds  .  .  .  shall  run  longer  than  ten  years,  nor  bear  interest  exceeding 
6  per  centum  per  annum.  The  credit  of  the  city  issuing  such  bonds  shall  be 
pledged  for  the  payment  thereof." 

The  Kansas  Digest  (Dassler  96),  gives  this  synopsis  of  the  law 
for  cities  of  the  second  class  as  interpreted  in  U.  S.  vs.  Fort  Scott, 
just  mentioned: 

"  Where  a  city  of  the  second  class  issues  improvement  bonds  for  improve- 
ments, for  which  the  law  provides  special  assessments  against  adjacent  prop- 
erty, a  bona- fide  holder  of  such  bonds  is  not  bound  to  enforce  his  judgment 
obtained  against  the  city  on  such  bonds,  by  the  special  assessments  provided 
for  by  law  or  ordinance.  He  is  entitled  to  a  mandamus  ordering  a  general 
levy  to  pay  his  judgment,  the  city  to  reimburse  itself  out  of  the  proper 
assessments." 

726.  The  bond  buyer  should  always  require  to  be  satisfied  on  this 
point  of  direct  municipal  obligations,  since  many  issues  reach  the 
public  with  their  status  not  yet  established.  The  federal  courts  are 
more  inclined  than  the  state  courts  to  view  them  as  general  obli- 
gations. 

727.  Assessed  Valuation.  The  Assessed  Valuation  of  the  district, 
especially  when  taken  in  conjunction  with  its  population,  will  indi- 
cate very  readily  whether  we  have  to  deal  with  a  rural  or  an  urban 
district.  If  urban,  a  comparison  of  the  assessment  of  the  district 
with  that  of  the  city  or  town  with  which  it  is  connected  will  indi- 
cate whether  the  district  is  only  a  section  of  the  municipality, 
whether  it  is  coextensive  with  the  municipality,  or  whether  it  em- 
braces the  municipality  and  other  territory  adjacent. 

728.  This  comparison  will  be  sound  because  the  basis  of  the 
assessment — that  is,  the  ratio  of  the  assessed  to  the  real  valuation — - 
is  almost  always  the  same  as  that  of  the  municipality  proper,  since 
the  valuations  are  adjusted  by  the  same  officers.  The  tax  district 
has  no  genuine  political  or  social  existence;  it  is  hardly  more  than 
an  abstraction,  usually  conceived  in  the  interests  of  convenience 
and  justice  for  territorial  apportionment  of  taxes.  Hence  there  is  no 
reason  for  separate  assessment. 

729.  The  assessed  valuation,  then,  which  is  identical  with  the 
valuation  of  the  same  area  of  the  municipality  proper  in  which  it 


248  THE  RONDS  OF  TAX  DISTRICTS 

is  si  tunic,  or  which  it  includes,  presents  to  the  investigator  no  diffi- 
culties that  have  not  already  been  discussed  in  the  preceding  chap- 
ters. 

730.  Secondary  Resources.  Since  the  taxing  district  maintains 
such  a  slight  corporate  existence  it  has  not  the  variety  and  wealth 
of  secondary  resources  customary  with  cities.  It  may,  and  usually 
does,  establish  a  sinking  fund  for  its  obligations,  but  it  seldom  is 
the  owner  of  treasury  assets  in  any  other  form.  Franchise,  cor- 
poration, and  other  corollary  taxes,  needless  to  say,  are  not  re- 
sources of  the  taxing  district  as  such. 

731.  Mortgage  Security.  The  resource  of  foreclosure  proceedings, 
however,  is  not  infrequently  available  to  holders  of  district  bonds; 
for  such  bonds  offer  mortgage  security  more  generally  than  do  any 
other  kinds  of  municipals,  as  may  be  seen  by  reference  to  the  pre- 
ceding chapter.  Mention  was  made  there  of  the  fact  that  School 
Dish  id  Bonds  in  the  state  of  New  Jersey  are  secured  by  lien  on  all 
the  property  in  the  district.  In  Illinois  there  is  a  sort  of  special 
assessment  Drainage  District  bonds  which  "  are  a  lien  on  the  lots, 
blocks,  or  parts  thereof  which  shall  be  designated  therein ;  but  before 
the  issue  the  owner  of  the  lots  ...  to  be  charged  must  indorse  upon 
the  back  of  such  bond  his  consent,  under  seal,  in  substance  as 
follows : 

"  '  I  hereby  indorse  the  within  bond  and  consent  that  the  lot,  or  lots,  or  parts 
thereof  therein  designated  shall  become  liable  for  the  interest  and  principal 
therein  named,  and  the  same  shall  be  a  lien  upon  said  property  from  this  date 
until  paid  off  and  discharged.  " 

"  The  bond  when  executed  by  the  city  or  village  and  so  indorsed  by 
the  owner  shall  be  recorded  in  the  Recorder's  office  in  the  county, 
and  such  record  shall  be  a  notice  of  the  lien  so  created  to  the  same 
extent  as  the  record  of  mortgages  is  a  notice."  1 

732.  In  California  (and  quite  generally  in  the  irrigated  states) 
;ill  the  real  property  of  irrigation  districts  is  liable  in  default. 
"  The  Board  of  directors  of  the  district  may  pledge,  by  mortgage  or 
otherwise,  all  property  of  the  district,  including  its  rights  and 
privileges,"  so  that,  in  default,  not  only  the  possession  and  man- 
agement of  the  water  system  comes  to  the  bondholders,  but  all 
other  property  of  the  district  may  be  foreclosed  under  the  mortgage 
in  the  ordinary  way  "  so  as  to  convey  to  the  purchaser  the  legal 
and  equitable  title  to  the  property." 

1  See  Hurd's  Revised  Statutes  of  Illinois,  Edit.  1908,  p.  372,  §§  327,  328. 


THE  BONDS  OF  TAX  DISTRICTS  249 

733.  District  Debt.  The  relation  between  debt  and  taxation  is 
so  direct  and  intimate  that  it  follows  from  the  nature  of  municipal 
taxation  that  the  debts  of  taxing  districts  are  comparatively  small 
and  simple,  and  that  the  debts  of  school  districts  bear  the  highest 
ratio  to  the  assessment.  But  the  nominal  debt  of  districts  is  a 
matter  quite  apart  from  the  real  debt,  of  course.  The  situation  has 
been  canvassed  so  completely  in  discussing  the  real  debts  of  other 
municipal  divisions  that  elaboration  is  unnecessary.  Still  to  illus- 
trate the  point  a  recent  circular,  offering  Cook  County,  Illi- 
nois, School  District  No.  76  bonds,  gives  the  "  total  bonded 
debt"  of  this  district  as  $57,500.  The  district  includes  the  south 
half  of  the  city  of  Evanston.  The  net  debt  of  Evanston  at  the  time 
was  over  $250,000.  Arbitrarily  assuming  that  one-half  of  this  debt 
was  the  direct  municipal  burden  upon  the  south  half,  we  are 
brought  to  the  conclusion  that  the  nominal  debt  of  the  district,  as 
presented  upon  the  circular  according  to  universal  custom,  was  not 
over  one-third  of  the  real  bonded  debt  of  the  district. 

734.  Validity.  The  fact  that  Special  Assessment  Bonds  may  come 
into  the  hands  of  the  investor  with  their  status  as  municipal  obliga- 
tions undecided  suggests  immediately  the  most  imminent  possibility 
of  weakness  in  District  issues:  their  validity.  District  Bonds  are 
the  product  of  special  conditions;  and  the  application  of  general 
principles  to  special  conditions  is  likely  to  be  a  matter  of  variance 
and  dispute. 

735.  This  is  especially  so  when  bonds  are  issued  in  behalf  of  a 
new  kind  of  project,  concerning  which  questions  of  law  have  not 
yet  had  the  benefit  of  judicial  decisions.  The  Wright  Act  in  Cali- 
fornia, under  which  so  many  irrigation  projects  were  initiated, 
brought  many  bondholders  to  grief.  Among  the  irrigation  districts 
in  that  state  which  have  been-  declared  illegally  organized,  or 
the  bonds  of  which  have  been  adjudged  illegally  issued,  are 
the  Alessandro,  the  Escondido,  the  Linda  Vista,  and  the  San  Jacinto 
and  Pleasant  Valley  districts;  and  the  list  might  be  extended. 

736.  After  extended  litigation  this  question  of  validity  has  been 
met  in  Indiana  in  the  case  of  Indiana  Gravel  Road  Township  bonds 
by  the  affirmation  of  the  State  Supreme  Court  as  to  their  legality. 
New  Jersey  frankly  recognizes  the  need  of  unusual  precautions  in 
this  respect  by  requiring  that  certified  copies  of  the  proceedings 
of  townships,  incorporated  towns,  or  borough  school  districts,  when 
they  issue  bonds,  be  submitted  for  the  approval  of  the  State  At- 
torney General. 


250  THE  BONDS  OF  TAX  DISTRICTS 

737.  Third  only  to  the  history  of  State  Bonds  and  Railroad  Aid 
bonds,  American  bond  law  has  no  more  interesting  chapter  than  that 
on  District  obligations.  Railroad  aid,  fortunately,  is  a  thing  of  the 
past,  for  the  most  part;  but  district  debt  incurrence  was  never  more 
common  than  to-day.  District  bond  litigation,  even  in  a  city  like 
San  Francisco,  with  excellent  municipal  credit,  is  by  no  means 
ancient  history.  It  never  redounds  to  the  credit  of  the  issuing  mu- 
nicipality. 

738.  Good  Faith.  Good  faith,  which  is  so  closely  associated  with 
validity,  is  not  to  be  expected  of  districts  in  that  high  degree  we 
find  it  nowadays  in  the  large  cities.  A  taxing  district  has  not  the 
individuality  or  personality  of  a  city  or  town  proper.  It  seldom 
has  a  wide  reputation  to  sustain.  There  is  a  prevalent  opinion, 
not  wholly  without  justification,  that,  other  things  being  equal, 
school  districts  are  most  safely  relied  on.  The  attitude  of  the  public 
toward  the  objects  for  which  funds  are  raised  has  had  much  to  do 
in  the  past  with  the  fate  of  civil  loans.  Just  as  the  hostility  of  the 
people  to  Louisiana  State  Bonds  issued  by  a  Republican  administra- 
tion, and  toward  Railroad  Aid  Bonds,  issued  in  the  interest  of  de- 
signing corporations,  has  brought  in  its  train  default  and  repudia- 
tion, so  the  pride  of  the  people  in  their  public  school  system  has  un- 
doubtedly upheld  the  credit  of  loans  raised  in  behalf  of  schools. 

739.  We  have  already  noticed  that  tax  districts  have  frequently 
been  formed  (e.g.  in  Tennessee  and  Minnesota)  for  the  sole  purpose 
of  evading  just  obligations.  The  following  clipping  from  the  Omaha 
Bee  of  Jan.  9,  1901,  cites  a  typical  instance  of  this  practice: 

"  The  case  grew  out  of  the  sale  of  bonds  by  the  precinct  of  Nebraska  City, 
Otoe  Co.,  in  aid  of  the  Missouri  Pacific  Railroad  Company.  According  to  the 
allegations  of  the  petition,  the  County  Commissioners  created  the  precinct  of 
Nebraska  City,  which  includes  the  town  of  that  name  and  adjoining  farm  land, 
for  the  sole  purpose  of  enabling  the  citizens  to  issue  the  bonds. 

"  The  bonds  were  issued  in  the  sum  of  $40,000,  and  sold,  the  plaintiff  pur- 
chasing $30,000  of  them.  Interest  was  paid  for  some  time  and  then  the  County 
Commissioners  refused  to  levy  a  tax  for  the  payment,  holding  that  the  creation 
of  the  precinct  was  illegal.     They  then  by  resolution  destroyed  the  precinct. 

"  In  his  judgment  Judge  Munger  ordered  the  Commissioners  to  levy  a  tax 
sufficient  to  pay  the  debt  due  the  plaintiff,  assessing  the  property  in  the  pre- 
cinct of  Nebraska  City  as  fixed  and  defined  Oct.  4,  1886,  the  date  the  bonds  were 
sold." 

740.  Practices  that  were  tolerated  in  the  eighties  are  no  longer 
possible  to  thieving  municipal,  any  more  than  they  are  to  private, 
corporations.    It  is  not  likely  that  any  of  us  shall  live  to  see  such 


THE  BONDS  OF  TAX  DISTRICTS  251 

violations  of  good  faith  as  those  in  Nebraska  City,  Memphis,  or  Du- 
luth,  in  past  generations. 

741.  Rural  Versus  Urban  Districts.  In  so  far  as  taxing  districts 
partake  of  the  nature  and  dignity  of  urban  municipalities,  their 
paper  is  to  be  desired  as  an  investment.  But  rural  districts,  even 
to  a  greater  extent  than  rural  counties,  are  difficult  of  appraisal ;  it 
is  hard  to  get  satisfactory  and  authentic  statements  by  which  to 
ascertain  the  tax  burden  of  the  rural  district,  its  geography,  its 
exact  status  as  a  corporation,  and  its  territorial  relations  to  the 
parent  corporation. 

742.  Butte,  Montana,  School  District  No.  1  may  properly  be  called 
an  urban  district,  since  it  comprehends,  not  only  the  entire  city  of 
Butte,  but  a  larger  portion  of  the  taxable  property  of  Silver  Bow 
County,  in  which  Butte  is  located.  Therefore  it  is  able  to  market 
its  bonds  as  4s  and  4^s.  The  other  school  districts  of  the  county, 
obviously  rural,  having  but  little  property  value  and  a  sparse 
population,  and  being  little  known,  would  be  of  small  interest  to 
the  bond  buver. 

743.  Metropolitan  Districts.  Metropolitan  districts,  like  metro- 
politan counties,  borrow  in  some  degree  the  credit  of  cities  with 
which  they  are  associated.  The  best  known  is  the  great  Chicago 
Sanitary  District,  which  includes  not  only  the  city  of  Chicago,  but 
a  large  area  of  adjacent  territory — in  all  about  360  square  miles. 
The  credit  of  the  Chicago  Sanitary  District,  although  not  equal  to 
that  of  Chicago,  is  exceptionally  high. 

744.  Many  well-known  cities  of  the  country  have  independent 
school  districts  which  enjoy  excellent  credit,  as  being  coextensive 
with,  or  as  including,  their  respective  cities.  Of  such  are  the  School 
Districts  of  Indianapolis,  Indiana,  Springfield,  Ohio,  and  Sioux  City, 
Iowa. 

745.  Conclusion,  Since,  now,  the  range  of  quality  in  District 
Bonds  is  greater  than  that  in  any  other  kind  of  municipal  issues, 
more  knowledge  and  discretion  are  necessary  to  their  proper  pur- 
chase ;  and  in  aid  of  the  purchase  the  arbitrary  rules  of  limitation, — ■ 
geographical,  statistical,  and  otherwise, — will  be  of  little  help  un- 
less interpreted  in  the  light  of  thorough  investigation  of  the  facts, 
fortified  by  the  opinion  of  a  competent  attorney.  But  when  intelli- 
gently bought,  a  higher  return  may  be  had  from  investment  in  Dis- 
trict Bonds  than  from  investment  in  other  municipal  issues  of  equal 
security. 


PART  III 
CORPORATION   LOANS 

CHAPTER  XX 

RAILROAD  BONDS:  PROPRIETORSHIP,  MANAGEMENT, 

AND  PLANT 

746.  To  write  of  railroad  bonds  is  at  once  the  easiest  and  the 
most  difficult  of  the  tasks  this  book  has  demanded.  It  is  the  easiest 
in  the  sense  that  the  investment  principles  to  be  laid  down  are, 
for  the  most  part,  of  general  acceptance  in  their  province,  and  es- 
tablished beyond  perad venture  by  years  of  application  to  the  busi- 
ness of  steam  transportation.  It  merely  remains  to  record  them. 
The  task  is  the  most  difficult  because  the  limits  of  these  chapters  de- 
mand elimination  of  so  much  interesting  and  valuable  matter  that 
is  almost  essential  to  the  intelligent  appraisal  and  selection  of  rail- 
road bonds.  It  is  easier  to  be  prodigal  of  scant  resources  than  to 
be  abstemious  amid  such  rich  material  as  we  have  here. 

Indeed  the  subject  is  so  big,  and  so  amply  repays  book  work,  that 
those  who  can  are  advised  to  read  the  studies  mentioned  in  the  foot- 
note, as  well  as  many  other  writings  which  can  be  noted  and  ap- 
proached by  following  up  these  references.1  The  author  has  not 
attempted  an  original  viewpoint  or  new  modes  of  treatment,  if 
these  be  possible.  Little  is  written  here  that  is  not  many  times  a 
repetition.  But  he  hopes  that  the  more  important  factors  which  bear 
directly  on  the  security  for  railroad  bonds  are  discussed  in  such  way 
that  all  can  see  their  relations  one  to  another  and  to  the  whole,  so 
that  each  investment  principle  can  be  studied  more  intensively  than 
here,  by  those  who  desire,  and  that  the  whole  scheme,  with  modifi- 

1  The  Anatomy  of  a  Railroad  Report,  Thomas  F.  Woodlock.  "  Railroad  Bonds 
as  an  Investment  Security,"  Floyd  W.  Mundy  (in  Bonds  as  Investment  Securi- 
ties, The  American  Academy  of  Social  and  Political  Science,  Philadelphia,  1907). 
The  Earning  Power  of  Railroads,  Floyd  W.  Mundy,  New  York,  published  annu- 
ally. American  Railways  as  Investments,  Carl  Snyder,  New  York,  1907. 
Moody's  Analysis  of  Railroad  Investments,  John  Moody,  New  York,  published 
annually.  Statistics  of  Railways  in  the  United  States,  annual  report  of  the 
Interstate  Commerce  Commission;  the  latest  yet  issued  is  for  the  year  ending 
June  30,  1909.     Railroad  Reorganizations,  1908,  Stuart  Daggett. 

252 


PROPRIETORSHIP,  MANAGEMENT,  AND  PLANT      253 

cations,  can  be  applied  to  the  types  of  public  service  and  other  bonds, 
which  follow,  without  the  necessity  of  repeating  these  principles  in 
their  entirety.  If  for  no  other  reason,  then,  these  chapters  on  rail- 
road bonds  should  be  read  in  anticipation  of  the  chapters  to 
come. 

747.  In  its  broadest  aspect  the  security  for  our  railroad  bonds 
lies  in  the  fact  that  American  railroading  is  the  greatest  single 
business  in  the  world.1  It  operates  about  a  quarter  of  a  million 
miles  of  track.  There  are  nearly  eight  miles  of  track  for  every  ten 
miles  square  of  land.  One  million  and  a  half,  out  of  our  total 
population  of  ninety-three  million,  are  in  the  railway  service.  About 
C  per  cent,  of  the  adult  male  population  of  the  country  are  railroad 
employees.  In  1895  there  were  327,000  recorded  shareholders  (or 
part  owners)  of  American  railways.  In  1910  the  number  reported 
for  116  operating  companies  was  746,221.  These  shareholders  in- 
clude many  fiduciary  holders:  agents,  trustees,  educational,  insur- 
ance, and  savings  institutions,  so  that  American  railways  count 
their  direct  and  indirect  owners  by  the  millions.  We  are  dealing 
with  a  business  capitalized  in  this  country  at  over  $17,000,000,000, 
of  which  about  $10,000,000,000  is  in  bonds.  We  seek  the  invest- 
ment  value  of  these  bonds. 

748.  The  fact  that  this  immense  railroad  carrier  business  has 
gradually  lifted  itself  from  a  plane  of  business  adventure  and  finan- 
cial piracy  to  that  of  a  national  institution— not  only  for  transporta- 
tion, but  for  investment, — and  that  this  semi-public  business  is  in- 
timately associated  with  almost  every  phase  of  the  nation's  well- 
being,  is  sufficient  guaranty  that  in  the  main  governmental  regula- 
tion of  this  business,  especially  by  the  federal  authorities,  will  work 
toward  a  better  conduct  of  transportation  and  more  certain  ele- 
ments of  stability  and  value  in  railway  securities. 

749.  Therefore,  among  corporation  securities,  it  is  truer  of  rail- 
roadLbonds  than  of  any  others  that  the  character  of  the  bond  itself 
is  of  consideration  secondary  to  the  character  of  the  obligor  cor- 
poration,  as  expressed  in  its  history  and  present  condition.  This 
is  not  saying  that  a  first  mortgage  bond  is  not  generally  better  than 
a  debenture,  but  it  does  affirm  that,  as  a  class,  the  debentures  of  the 
great  trunk  lines  are  stronger  than  the  first  mortgage  main  line 
bonds  of  the  smaller,  less  well-managed  roads,  built,  for  instance, 
to  be  outlets  for  otherwise  inaccessible  mines  or  timber  tracts. 

1  Not  classifying  agriculture  under  business. 


254  RAILKOAD  BONDS 

Control,  Proprietorship,  and  Management 

750.  It  is  a  common  sense  way  of  looking  at  the  thing,  after  all, 
if  the  prospective  buyer  approaches  his  railroad  bond  investigation 
as  he  would  approach  the  matter  of  making  a  loan  to  almost  any 
kind  of  going  business  concern.  His  first  thought  is  of  the  character 
and  credit  of  the  proprietors.  Among  railroads,  public  interest  is 
such  that  this  first  step  is  without  difficulty,  so  far  as  it  relates 
to  the  financial  leaders  or  interests  that  dominate  or  have  dominated 
the  road.  Mr.  Snyder's  comments  on  the  strong  tendency  of  rail- 
roads to  perpetuate,  through  generations,  good  or  evil  character- 
istics have  already  been  quoted.  Heredity  counts  for  more  than 
most  people  realize.  It  is  a  matter  not  of  years  but  of  decades  to 
change  the  nature  of  a  railroad.  A  knowledge  of  the  conduct  of  a 
railroad  stock  on  the  exchange,  over  a  period  of  years,  and  of  its 
dividend  record,  its  history  in  receivership,  will  l)e  a  crude  but 
reasonably  safe  guide  to  the  general  health  of  the  road. 

751.  As  to  the  present,  ownership  and  control  may  in  some  cases 
be  looked  upon  as  two  separate  and  distinct  aspects  of  proprietor- 
ship. The  distribution  of  Pennsjivania  stock  among  a  large  body 
of  people,  who  look  for  income  from  it  rather  than  profit,  differ- 
entiates the  Pennsylvania  so  markedly  from  Reading,  the  control 
of  which,  despite  the  interest  in  it  of  the  Baltimore  and  Ohio  and 
the  Lake  Shore,  is  in  the  hands  of  a  few  who  are  presumed  to  be 
as  much  interested  in  the  profits  accruing  from  variations  in  the 
market  value  of  the  stock  as  from  dividends.  Yet  in  many  jmysical 
respects  these  two  strong  roads  are  very  similar. 

752.  There  is  much  to  be  learned  from  the  history  of  any  proprie- 
torship or  control.  The  holders  of  the  underlying  bonds  of  one  of  the 
great  Western  systems  have  equities  in  earnings  and  securities  which 
make  the  obligations  appear  of  a  very  high  type.  But  an  analysis  of 
the  methods  by  which  a  comparatively  small  outlay  of  money  ob- 
tained control  of  this  property,  by  a  system  of  holding  companies 
and  stock  pyramiding,  will  not  reassure  a  careful  bond  buyer  that 
his  interest  will  be  conserved.  When  only  a  few  millions  of  cash 
were  necessary  to  control  a  property  bonded  for  some  hundreds  of 
millions,  the  market  price  of  the  best  of  its  bonds  was  sure  to  suffer 
severely  when  it  appeared  that  the  road  might  not  be  able  to  meet 
all  of  its  obligations. 

753.  Where  there  is  a  truly  dominating  interest,  such  as  Moffat 
in  the  Denver,  Northwestern,  and  Pacific;  Flagler  in  the  Florida 


PROPRIETORSHIP,  MANAGEMENT,  AND  PLANT      255 

East  Coast;  Atkinson,  in  the  Atlantic  and  Birmingham;  Hawley, 
in  the  Chicago  and  Alton,  or  Hill  in  the  Great  Northern,  the  in- 
evitable questions  are:  is  this  a  capable  railroad  man;  is  he  con- 
servative and  constructive ;  who  are  his  bankers ;  in  what  other  roads 
is  he  interested,  and  what  other  connections  has  he?  The  same 
questions  hold  good  for  a  dominating  group  of  men. 

754.  No  railroad  development  of  the  past  ten  years  has  greater 
significance  to  bond  buyers  than  the  general  recognition  of  the 
necessity  for  the  entente  cordiale  among  the  companies,  which  arises 
from  a  "  community  of  interest."  The  youngest  of  those  who  have 
interest  in  financial  matters  remember  the  day  of  rate  wars  which 
precipitated  so  many  roads  into  bankruptcy.  When  freight  tariffs 
could  not  be  maintained  legally  by  competing  carriers,  through  the 
agency  of  a  pool,  the  desired  result  was  obtained  by  the  creation  and 
recognition  of  a  community  of  interest.  The  ownership  by  one  road 
of  the  stock  of  another,  with  consequent  dovetailing  of  directorates, 
led  to  amicable  understanding  and  concert  in  action,  when  other- 
wise there  might  have  been  costly  warfare. 

755.  But  traffic  alliances  may  exist  without  stock  ownership. 
In  this  event  the  visible  evidence  of  cooperation  is  to  be  found  in 
the  duplication  of  officers  or  directors.  It  is  especially  important 
that  the  smaller  independent  roads  that  do  not  originate  sufficient 
traffic  to  make  them  self-sustaining,  should  have  the  benefit  of 
friendly  connections  with  a  powerful  system  to  relieve  them  of  the 
possibility  of  destructive  competition.  In  the  case  of  an  aggressive 
independent  road  this  possibility  may  be  an  impending  probability. 
There  are  well-known  small  roads  to-day  that  are  mentioned  in 
these  pages,  which  have  greater  difficulty  in  maintaining  their  cor- 
porate independence  against  the  aggressions  of  larger  systems  than 
they  do  in  maintaining  the  standard  of  their  service  or  the  suffi- 
ciency of  their  earnings.  The  recognition  of  the  community  of 
railroad  interest  has  done  more  than  anything  else,  except  the 
general  development  of  the  country  and  of  the  railroads  themselves, 
to  place  railroad  finance  upon  its  present  stable  footing. 

756.  Management.  Management,  as  distinguished  from  control, 
may  be  looked  upon  as  relating  to  railroad  internal  policies  and  to 
the  manifestation  of  these  policies  in  the  road's  operating  statistics. 
Subordinate  in  public  interest  to  the  financial  heads,  the  rail- 
road managers  and  their  work  will  be  best  known  to  the  in- 
quiring investor  in  the  records  of  physical  and  operating  efficiency. 


256  RAILROAD  BONDS 

Physical  Characteristics 

757.  The  second  step  in  the  investigation  of  almost  any  business 
is  a  study  of  the  physical  properjv.  Lines  of  inquiry  as  to  both 
physical  and  financial  condition  are  first  laid  in  the  annual  report. 
But  as  any  study  must  becouiparative,  the  results  obtained  from  the 
report  must  be  weighed  in  the  light  of  previous  reports,  and  of  the 
reports  of  other  roads  operating  under  conditions  sufficiently  simi- 
lar to  lend  value  to  the  comparison.  Ordinarily  geographical  prox- 
imity is  the  best  basis  for  choosing  roads  for  comparison.  This  is 
a  leading  cause  for  the  grouping  of  railroads,  according  to  location, 
by  the  Interstate  Commerce  Commission.  But  for  some  purposes 
of  comparison,  grouping  according  to  the  character  of  the  traffic, 
or  of  the  mileage  operated,  is  more  advisable.  Nothing  but  common 
sense  or  a  familiarity  with  statistical  methods  will  determine  the 
proper  course  for  any  particular  purpose. 

758.  The  annual  "  Statistics  of  Railways  "  of  the  Interstate  Com- 
merce Commission,  which  may  be  obtained  at  Washington,  are 
invaluable  for  comparison.  But  unfortunately  these  reports  are 
issued  a  year  in  arrears,  and  to  this  serious  extent  are  handicapped 
in  their  usefulness.  Whatever  difference  of  opinion  may  exist  as  to 
the  various  phases  of  the  work  of  the  Commission,  it  cannot  be 
denied  that  a  great  service  has  been  rendered  to  investors,  and  to 
other  students  of  railway  practice  and  finance,  as  well  as  to  railway 
men  themselves,  by  the  policy  of  the  Commission  in  gradually 
shaping  into  uniformity  of  plan,  American  railway  statistics  of 
operation,  earnings,  and  capitalization. 

759.  For  an  understanding  of  the  physical  properties  there  may 
be  added  to  these  sources  of  information  one  of  the  several  sets 
of  railroad  maps  now  published.  Perhaps  the  most  accessible  maps, 
though  not  the  most  detailed,  are  those  incorporated  in  the  Railway 
and  Industrial  supplements  to  the  Commercial  and  Financial 
Chronicle.  Maps  of  all  the  roads  do  not  appear  in  any  one  supple- 
ment. 

760.  By  means  of  these  few  helps  one  has  excellent  material  with 
which  to  study  the  physical  characteristics  of  railroads  as  they 
bear  upon  one's  investment  estimate  of  the  road.  The  essential 
problems  one  will  consider  are 

a — the  location  of  the  road, 

b — its  size  or  mileage, 

c — the  character  of  its  traffic, 


PROPRIETORSHIP,  MANAGEMENT,  AND  PLANT      257 

d — the  character  and  condition  of  the  equipment, 
e — the  operating  efficiency. 

761.  Location.  By  location  we  mean,  in  general,  the  geographical 
situation,  and,  in  particular,  the  strategic  position.  The  geo- 
graphical situation  determines  the  nature  of  the  traffic  and  there- 
fore the  character  of  the  earnings.  Every  one  naturally  classifies 
roads  according  to  their  major  business.  We  speak  familiarly  of 
the  "  grangers  "  of  the  Northwest,  the  "  coalers,"  hard  and  soft,  of 
the  Northeast,  and  the  cotton  carrying  roads  of  the  South. 

A  firm  grasp  of  this  grouping  according  to  the  major  character- 
istics makes  possible  fairer  comparisons  of  roads,  and  keener  appre- 
ciation of  their  relative  excellencies  in  such  significant  details  as 
train  loads  and  traffic  density,  of  which  we  shall  have  more  to  say 
presently. 

762.  The  geographical  position  suggests  inquiry  into  the  probable 
future  of  the  road  as  affected  by  shifts  in  population  and  growth 
in  property  valuation.  The  trend  of  population  is  found  in  census 
reports,  and  valuations  can  be  ascertained  along  the  lines  suggested 
in  the  chapters  on  City  and  Town  Bonds.  In  later  pages  an  effort 
will  be  made  to  indicate  graphically  the  relation  between  population, 
wealth,  and  railroad  securities  in  particular,  for  the  country  as  a 
whole. 

763.  Strategic  position  is  of  great  importance.  The  line  without 
a  competitor  for  local  business,  or  with  the  shortest  haul,  or  with 
the  water-level  grade,  or  with  the  best  terminal  facilities,  com- 
mands greatest  credit,  other  things  being  equal.  The  location  de- 
termines the  amount  of  the  through  traffic,  and  the  ratio  of  the 
passenger  to  the  freight  business,  and  the  diversity  of  the  tonnage. 
Location,  therefore,  is  the  first  of  the  physical  characteristics  to  be 
studied. 

764.  Mileage.  Roads  are  more  technically  classified  by  their 
size:  i.e.  in  accordance  with  the  average  number  of  miles  of  single 
main  track  which  they  directly  operate, — whether  owned  or  not. 
Mileage  classification  is  not  generally  comprehended.  It  is  im- 
portant because  the  necessities  of  comparison,  especially  in  studying 
operating  efficiency,  make  imperative  a  clear  understanding  of 
mileage.  Obviously  the  gross  tonnage,  earnings,  or  charges  of  a 
5,000-mile  road  cannot  be  compared  with  those  of  a  500-mile  road 
without  reduction  to  a  common  unit  of  measure.  But  if  the  tonnage, 
earnings,  or  charges  are  divided  by  the  number  of  miles  operated, 
after  making  proper  deductions  there  is  a  basis  of  comparison. 


258  RAILROAD  BONDS 

765.  For  uniformity  and  for  other  reasons  "  operated  mileage" 
does  not  include  miles  of  extra  track,  whether  main,  siding,  or 
switch.  The  reports  will  give  separately  the  mileage  of  this  extra 
track  and  the  nature  of  it,  and  whether  it  is  owned  or  leased,  so 
that  proper  deductions  may  he  made.  Prohably  most  people,  at 
least  in  the  East,  overestimate  the  amount  of  extra-track  road 
in  the  United  States.  Exclusive  of  the  mileage  operated  by  switch- 
ing and  terminal  companies,  the  Commission  reports  the  total 
mileage  operated  (all  tracks)  on  June  30,  1908,  as  333,646  miles,  of 
which  230,494  miles  were  single  track  mileage,  20,209  miles  were 
second  track  mileage,  2,081  miles  were  third  track  mileage,  1,409 
miles  were  fourth  track  mileage,  and  79,453  miles  were  yard-track 
and  sidings. 

766.  Although  growth  in  extra  main-track  mileage  is  a  sign  of 
traffic  intensity,  in  making  allowances  it  must  not  be  expected  that 
each  extra  track  increases  proportionately  the  tonnage  capacity. 
There  is  no  fixed  rule  of  allowance  for  extra-track  purposes  of  com- 
parison. A  thorough  knowledge  of  the  road  and  of  the  traffic  must 
be  the  guide. 

767.  In  railroading,  if  nowhere  else,  mere  bigness  is  an  advantage. 
It  makes  possible  the,Iong  haul,  of  which  we  have  spoken,  and  tends 
to  diversify  the  traffic^  and  thus  in  turn  insures  against  too  radical 
a  reduction  of  earnings  on  the  failure  of  a  local  crop,  mine,  or 
industry. 

768.  The  Character  of  the  Traffic.  This  thought  suggests  the  chief 
good  of  an  analysis  of  the  traffic.  It  enables  us  to  judge  how  differ- 
ent sorts  of  conditions  will  affect  the  road's  future  efficiency  and 
earning  power.  For  instance,  with  knowledge  that  one-half  of  the 
New  Haven  road's  business  is  passenger,  and  that  its  tonnage  is 
highly  diversified,  and  that  so  much  of  its  business  is  short  haul, 
we  shall  be  led  to  expect  future  earnings  in  close  conformity  to  the 
degree  of  general  prosperity  enjoyed  in  New  England.  But  in  the 
case  of  the  Bangor~lm(f^ Aroostook,  which  draws  nearly  three- 
quarters  of  its  business  from  freight,  and  which  serves  a  country 
not  as  fertile  or  prosperous  as  some  others,  the  failure  of  a  potato 
crop,  or  a  slackening  in  the  demand  for  lumber,  might  make  serious 
inroads  on  its  income,  despite  generally  good  business  conditions  in 
New  England. 

769.  In  view  of  the  importance  of  traffic  analysis,  particularly 
of  freight  analysis,  it  is  the  purpose  of  the  Commerce  Commission 
to  supplement  its  present  accounting  structure   with   a  uniform 


PROPRIETORSHIP,  MANAGEMENT,  AND  PLANT      250 

classification  of  commodities  carried  as  freight.  Most  railroads  re- 
port their  tonnage  in  accordance  with  the  classification  now  used 
by  the  Commission.  Its  main  headings,  and  its  application  to  the 
Bangor  and  Aroostook  for  1903  and  1909  are  as  follows : 

1903  1909 

Products  of  Agriculture 17.27$  29.75$ 

"         «  Animals  1.82  1.19 

"         "  Mines 8.68  9.51 

"         "  Forests 41.54  37.73 

Manufactures 11.88  15.14 

Merchandise  and  Miscellaneous 18.81  6.78 

These  main  headings  are  freely  subdivided  by  the  Commission  for 
the  benefit  of  those  who  wish  to  make  more  exhaustive  studies ;  but 
we  do  not  give  the  subdivisions  here. 

770.  By  observing  the  alterations  in  the  absolute  and  the  relative 
amounts  of  the  various  kinds  of  tonnage  over  a  period  of  years  an 
intelligent  opinion  can  be  formed  of  the  road's  growing  dependence 
upon,  or  independence  of,  any  one  or  few  industries.  By  comparing 
results  thus  obtained  with  results  of  other  roads  in  the  same  terri- 
torial group,  or  specializing  in  the  same  kinds  of  traffic,  one  obtains 
some  idea  of  the  weakness  or  strength  of  the  road  in  diversifi- 
cation of  tonnage.  In  general,  the  more  diversified  the  traffic,  the 
better. 

771.  The  Character  and  Condition  of  the  Equipment.  The  casual  in- 
vestigator will  probably  be  somewhat  at  a  loss  to  know  how  to  turn 
to  account  the  figures  of  the  report  that  relate  to  equipment.  They 
are  not  as  illuminating  as  some  other  figures,  for  at  best  they  cannot 
indicate  the  actual  condition  of  the  equipment.  It  may  even  be  a 
question  to  determine  just  what  rolling  stock  is  owned  by  the  road, 
and  what  is  its  equity  in  that  stock  used  but  not  owned.  The  chap- 
ter on  Equipment  Bonds  (see  p.  292)  will  make  clear  the  condi- 
tions that  bring  about  the  common  use  of  engines  and  cars  that  are 
not  owned  by  the  road.  By  equipment  is  meant  here,  not  only  this 
rolling  stock,  but  such  other  movable  property  as  transports, 
ferries,  tugs,  etc., — but  not  buildings  or  any  part  of  the  established 
plant. 

772.  Although  it  is  difficult  to  elicit  from  the  report  the  informa- 
tion desired  concerning  the  condition  of  the  equipment,  neverthe- 
less its  importance  is  not  to  be  questioned.     The  rolling  stock  is 


260  RAILROAD  BONDS 

the  tools  with  which  the  company  must  do  its  work.  The  efficiency 
of  the  road's  operation  depends  in  large  part  upon  engines  and  cars 
adequate  in  number,  modern  in  design  and  structure,  and  in  good 
repair.  Put  an  old-time  wood  flat  car  in  the  middle  of  a  40-car 
train  and  the  tractive  force  will  pull  the  ends  out  of  it,  or  on  a  down 
grade  the  compression  will  buckle  it  double.  Rolling  stock  is  that 
part  of  the  properly  which  depreciates  most  quickly,  and  therefore 
the  condition  of  which  is  a  most  striking  index  of  the  present  policy 
of  the  management. 

773.  The  relation  between  an  increase  in  the  amount  of  equip- 
ment and  in  traffic  development  is  more  than  a  numerical  computa- 
tion because  of  the  probable  increased  power  of  the  engines,  and  of 
the  endurance,  capacity,  and  serviceableness  of  the  cars.  In  no  de- 
partment of  railroading  is  progress  greater  than  in  the  development 
of  the  rolling  stock. 

774.  Nearly  all  railroads  show  an  annual  increase  in  the  amount 
of  rolling  stock  owned.  If  the  percentage  of  increase  of  equipment 
purchased  or  used  in  trust  is  greater  than  the  percentage  of  mileage 
increase,  there  is  a  probable  increase  in  traffic  density.  But  the 
character  of  the  traffic  has  its  bearing  on  this  matter.  Coal  trans- 
portation, for  instance,  will  require  a  return  of  empty  cars,  but 
passenger  traffic  will  more  nearly  equalize  itself  to  and  fro.  Sud- 
den changes  in  the  operated  mileage,  due  to  purchase  or  lease,  and 
involving  no  real  loss  or  acquisition  of  rolling  stock,  must  be  con- 
sidered in  relation  to  the  amount  of  equipment,  if  that  has  been  re- 
duced to  a  mileage  basis. 

775.  Statistics  of  Operation.  However  favorable  or  unfavorable 
to  railroad  development  the  laws  of  the  country  become,  nothing 
short  of  confiscation  can  jeopardize  the  security  in  redemption  (as 
distinguished  from  security  in  liquidation)  of  bonds  that  are  an 
underlying  lien  on  trackage  doing  a  steady  and  heavy  business. 
Therefore  we  get  right  at  the  heart  of  the  principles  of  railroad  bond 
investment  when  we  go  straight  to  the  road  and  learn  the  volume 
of  its  traffic  and  the  efficiency  with  which  this  traffic  is  moved.  If 
the  road  is  doing  much  carrying  and  doing  it  economically,  the 
earnings  will  pretty  nearly  take  care  of  themselves. 

776.  We  cannot  neglect  the  study  of  earnings  (to  which  we  shall 
come  presently),  because  too  much  striving  after  present  economies 
may  cripple  future  efficiency.  We  must  therefore  examine  main- 
tenance appropriation  to  settle  .this  point.  Or  maybe  the  road  is 
carrying  too  heavy  a  burden  of  debt,  and  underlying  liens  that  are 


PROPRIETORSHIP,  MANAGEMENT,  AND  PLANT      2fil 

theoretically  protected  by  heavy  mileage  earnings  may  be  practically 
in  danger.  But  as  a  general  and  fairly  sate  rule,  a  road  that  is 
doing. a  sufficient  business,  and  in  workmanlike  fashion,  has  nothing 
to  fear. 

777.  By  the  amount  of  business  done  is  meant,  not  the  absolute 
number  of  passengers  and  tons  carried,  but  the  number  carried, 
times  the  average  distance  in  miles  each  passenger  or  ton  is  carried, 
divided  by  the  average  number  of  miles  operated  during  the  year. 
In  other  words,  since  it  is  the  intensity  of  the  work  rather  than  the 
volume  that  counts,  we  must  reduce  the  units  of  work  to  the  com- 
mon denominator  of  one  mile.     One  of  the  factors  of  operating  . 
efficiency,  then,  is  the  traffic  density,  which  is  made  up  of  the  pas-    '.      '  V 
senger  and  the  freight  density,  and  the  relative  importance  of  each         £j 
to  any  road  depends  on  the  ratio  of  passenger  to  freight  business          ^ 
done  by  that  road.    Passenger  density  is  the  number  of  passengers       £>• 
that  have  been  carried,  times  the  miles  each  has  been  carried,  divided 

by  the  miles  of  road;  or  (the  same  thing),  the  total  number  of 
passengers  carried  one  mile,  per  mile  of  road.  Freight  density, 
likewise,  is  the  number  of  tons  carried  one  mile,  divided  by  the 
mileage  of  the  road,  or  the  number  of  tons,  times  the  distance  car- 
ried, per  mile  of  road.  It  seems  very  difficult  for  the  layman  to 
grasp  these  highly  important,  but  very  simple  ideas  of  the  units 
of  work  performed  by  a  railway. 

778.  Once  the  idea  of  traffic  density  is  grasped,  comparisons  over 
a  period  of  years,  and  with  other  roads  in  the  group,  become  easy. 
One  or  two  points,  however,  are  to  be  observed.  An  increase  in 
traffic  density  usually  means  an  increase  in  gross  business  and  in 
earnings;  but  density  must  always  be  checked  for  mileage  reduced 
or  increased  since  previous  years.  Furthermore  ireignt  density  is 
a  matter  of  weight,  and  the  heavier  types  of  freight  are  the  less 
profitable  to  transport.  Hence  an  increase  in  freight  density,  to  be 
favorable  to  earnings,  must  not  signify  merely  an  increase  in  the 
relative  amount  of  the  kinds  of  heavy  traffic. 

779.  Another    factor   of   operating   efficiency   is   the   trainload.   £ 
The  train,  with  its  engine  and  crew,  is  an  important  physical  trans- 
portation unit  because  there  is  such  a  definite  irreducible  minimum 

of  expense  attending  the  movement  of  it.  At  least  the  expense  of 
engine,  engineer  and  fireman,  conductor,  and  some  brakemen,  right- 
of-way,  switching,  etc.,  etc.,  is  necessary  whether  the  train  is  full 
or  empty,  whether  there  are  three  cars  or  thirty.  Therefore  the 
more  business  that  can  be  accomplished  by  each  train  the  better. 


262  RAILROAD  BONDS 

Thus  trainioad  takes  its  place  as  an  index  of  traffic  density  and 
operating  efficiency. 

780.  The  carload  is  a  smaller  transportation  unit  having  the 
same  bearing  on  our  studies.  Obviously  the  skilful  traffic  manager 
will  endeavor  to  keep  each  car  as  nearly  as  possible  at  its  maximum 
capacity  by  regulating  traffic  so  that  "  empties "  will  not  be  re- 
turned to  him.  The  financial  heads  will  cooperate,  by  making  traf- 
fic alliances  that  will  assure  balance  in  traffic  movement.  This 
was  one  of  the  several  purposes  of  the  acquisition  of  the  Colorado 
and  Southern  by  the  Chicago,  Burlington  and  Quincy,  in  the  in- 
terest of  the  Hill  roads. 

781.  The  -passenger  trainioad  is  the  passenger  mileage  (or  tha 
total  number  of  miles  passengers  have  been  carried)  divided  by  the 
passenger  train  mileage  (or  the  number  of  miles  run  by  all  pas- 
senger trains)  during  the  year.  Since  freight  traffic  on  most  roads 
comprises  the  bulk  of  the  business,  and  is  so  much  the  more  profit- 
able traffic,  more  study  is  usually  put  on  the  freight  trainioad.  This 
is  the  freight  mileage  divided  by  the  freight  train  mileage. 

782.  Here,  too,  one  must  be  circumspect  in  the  use, of  figures. 
Much  freight  carrying  is  "  company  business,"  done  by  work  trains, 
such  as  the  hauling  of  dirt  from  cuts  or  to  fills.  This  is  not  directly 
revenue-producing  business,  and  is  separately  itemized  in  reports. 
It  will  be  omitted  from  comparisons.  The  trainioad  may  be  checked, 
for  very  refined  analysis,  by  considering  the  amount  of  business 
done  by  trains  with  two  or  more  engines.  For  this  purpose  engine- 
miles  may  be  substituted  (but  not  accurately)  for  train  miles.  In 
comparison  of  systems,  the  nature  of  the  traffic  and  the  nature  of 
the  country  through  which  the  roads  pass  will  have  a  very  ma- 
terial bearing  on  trainloads  and  the  like. 

\ 


CHAPTER  XXI 

RAILROAD  BONDS:  EARNING  POWER  AND  THE  INCOME 

ACCOUNT 

783.  To  those  accustomed  to  look  upon  a  railroad  as  a  huge  and 
complicated  transDortation  mechanism,  the  success  or  failure  of 
which  is  dependent,  as  in  any  other  mechanism,  on  the  efficiency 
of  the  many  parts,  earning  power  immediately  becomes  thought  of 
in  relation  to  these  parts.  Gross  earnings  are  reduced  to  units  of 
mileage  pure  and  simple,  or  to  train  mileage,  or  car  mileage,  or 
what  not,  in  accordance  with  the  point  of  view  and  the  object  in 
hand.  Among  the  traffic  averages  for  American  roads,  reported 
by  the  Interstate  Commerce  Commission,  are  the  following  which 
relate  to  earnings  per  mile  of  road : 

Passenger  service  train  revenue, 

Freight  service  train  revenue, 

Operating  revenue, 

Operating  expense, 

Net  operating  revenue  (or  deficit). 

784.  But  earnings  are  related  to  capital  as  well  as  to  operating 
costs,  and  they  are  more  easily  analyzed  in  relation  to  ledger  and 
balance  sheet,  and  this  method  of  analysis  is  the  more  necessary  in 
railroading  because  of  the  complex  intercorporate  relations  that 
now  obtain  among  transportation  companies. 

785.  It  is  one  of  the  great  services  rendered  by  the  Commission) 
that  they  now  require  of  the  roads  a  system  of  accounting  almost 
uniform  in  its  principal  items,  and  of  such  nature  as  to  be  in- 
telligible—to  ~aIH  Unfortunately,  to  achieve  this  result,  it  was 
deemed  necessary  to  alter  somewhat  the  terminology  and  classi- 
fications of  the  accounts  as  customarily  rendered  the  public  in 
the  past.  Under  the  circumstances  it  seems  best  to  interpret 
the  account  as  itemized  by  the  Commission.  The  items  are  as 
follows : 

261 


264  RAILROAD  BONDS 

786.  The  Income  Account  for  Operating  Roads 

Rail  operations, 

Operating   revenues, 
Operating  expenses 

Net  operating  revenue, 

Outside  operations,1 
Revenues, 
Expenses, 

Net  revenues  from  outside  operations. 

Total  net  revenue, 
Taxes  accrued, 

Operating  income, 
Other  income, 

Gross  corporate  income, 

Deductions  from  gross  corporate  income, 

Net  corporate  income 
Disposition  of  net  corporate  income, 

Dividends  declared  from  current  income, 
Additions  and  betterments  charged  to  income, 
Appropriations  to  reserves  and  miscellaneous  items, 

Total, 

Balance  to  credit  of  profit  and  loss, 

787.  The  simpler  form  of  income  account,  with  which,  in  one  or 
another  of  its  variations,  most  people  are  more  familiar,  is  now 
given,  with  the  corresponding  items  in  the  Commission's  account : 


~                  .  [  Operating  revenues 

Gross  earnings J 


Revenues  from  outside  operations 


^  (  Operating  expenses 

Operating  expenses \  T_r  „         ., 

[  Expenses  of  outside  operations 

1  For  a  definition  of  Outside  Operations  see  §  822. 


EARNING  POWER  AND  THE  INCOME  ACCOUNT      265 

Net  earnings Total  net  revenue 

Other  income Other  income 

Total  net  income Gross  corporate  income 

Fixed  charges Deductions  from  gross  corporate  income 

Surplus Net  corporate  income 

788.  Sometimes  certain  kinds  of  outside  operations  did  not  find 
their  way  into  the  income  account  except  as  net  revenue  included  in 
other  income.  Other  differences  between  the  old  and  the  new 
form  of  accounting  will  be  taken  up  in  the  comments  on  these 
items. 

789.  Operating  Revenues.  Operating  revenues,  or  gross  earnings, 
refer  to  income  derived  for  the  most  part  from  the  actual  movement 
of  traffic  (rail  operations).  Its  character,  and  the  relative  impor- 
tance of  its  component  parts,  in  1908  will  be  seen  from  the  analysis 

Proportion    to   total 
operating     revenues 
Item  ( per  cent.) 

Freight  revenue 69.15 


■to* 


Passenger  revenue 23.68 

Mail  revenue    2.03 

Express  revenue 2.45 

Excess  baggage  revenue  and  milk  revenue 54 

Parlor   and   chair   car   revenue   and    other   passenger 

revenue   14 

Switching    revenue 82 

Special  service  train  revenue  and  miscellaneous  trans- 
portation  revenue    30 

Total  revenue  from  operations  other  than  transporta- 
tion   89 

Unclassified    

Total    100.00 

790.  The  percentage  figures  in  this  and  the  subsequent  tables 
cannot  be  used  as  standards  of  favorable  or  invidious  comparison 
with  any  one  road.  They  represent  merely  the  average  importance 
of  various  items,  and  therefore  the  degree  of  attention  they  should 
receive  from  the  investor.  Since  freight  revenue  is  ordinarily  more 
lucrative  than  passenger,  and  is  the  source  of  more  than  two-thirds 
of  all  operating  revenues,  one  can  realize  from  this  percentage 


266  RAILROAD  BONDS 

table  why  the  railroad  and  the  public  mind  is  so  much  more  con- 
cerned with  freight  tariffs  than  with  passenger. 

791.  At  this  point  we  are  reminded  again  of  the  importance  of  a 
previous  investigation  of  the  physical  characteristics  of  the  road:  of 
the  relative  volume  of  the  different  kinds  of  traffic,  and  the  probable 
future  change  in  their  ratios,  due  for  example  to  the  opening  up  of 
a  section,  or  the  further  development  of  it.  The  kind  of  traffic 
largely  determines  the  transportation  rate,  and  the  rate  times  the 
density  of  this  traffic  determines  the  revenue.  Since  density  is  the 
volume  of  business  reduced  to  a  mileage  basis,  and  the  rate  is  the 
charge  per  mile,  it  is  necessary  to  study  operating  revenues,  also, 
on  a  mileage  basis.  But  there  is  little  significance  in  the  bald  fact 
that  one  road  has  greater  gross  earnings  per  mile  than  another, 
unless  they  are  operating  under  very  similar  traffic  conditions. 

792.  Since  in  this  country  the  general  trend  of  rates  for  years 
has  been  downward  or  stationary,  and  that  of  materials  and  labor 
has  been  upward,  it  follows  that  the  general  increase  in  earnings 
per  mile  has  been  accomplished  only  by  a  more  intense  traffic, 
which,  in  turn,  is  the  result  of  an  increased  operating  efficiency  ap- 
plied to  a  growing  volume  of  business.  The  course  of  argument 
recently  pursued  by  counsel  representing,  at  Washington,  those 
who  are  opposed  to  increase  in  freight  tariffs  fails  to  show  an 
appreciation  of  this  fact.  If  the  railroads  exhibit  imperfect  organi- 
zation and  imperfect  business  development,  especially  along  the 
line  of  operating  economies,  it  is  yet  to  be  proved  that  their  effi- 
ciency has  not  grown  as  rapidly  as  business  efficiency  in  general,  to 
put  the  case  very  mildly. 

793.  Operating  revenues  may  profitably  be  considered  not  only 
historically,  on  a  mileage  and  train  mileage  basis,  to  realize  the 
volume  of  earnings  and  the  efficiency  of  operation,  respectively,  but 
also  in  relation  to  net  capitalization.  But  this  study  must  be  left 
until  we  consider  what  is  net  capitalization. 

794.  Operating  Expenses.  Before  discussing  the  nature  of  operat- 
ing expenses  a  word  of  caution  as  to  comparisons  of  present  with 
past  years.  Whereas,  formerly  the  hire  of  equipment  was  frequently 
included  under  this  head,  when  that  item  was  a  debit,  and  also 
taxes,  now  these  items  must  be  accounted  for  elsewhere.  Proper 
allowances,  therefore,  often  will  have  to  be  made. 

795.  Railroads  are  as  helpless  as  other  business  organizations  in 
attempting  to  stop  the  ebb  of  earnings  in  business  depression.  To 
maintain  adequate  surplus  their  chief  resource  is  in  curtailing  and 


EARNING  POWER  AND  THE  INCOME  ACCOUNT      267 

redirecting  expenses.  Interest  charges  and  taxes  are  virtually  fixed ; 
dividends,  if  any,  may  be  reduced  or  passed ;  but  dividend  reduction 
may  be  politically  unwise,  and  may  impair  credit.  Operating  ex- 
penses, however,  will,  of  themselves,  rise  and  fall  to  some  extent  with 
the  amount  of  work  performed.  Because  of  the  peculiar  makeup 
of  this  account,  the  rise  and  fall  may  be  intensified  and  thus  admit 
great  savings  in  lean  years.  Railroads  now  report  to  the  Com- 
mission under  the  following  heads : 

Proportion    to   total 
operating     expenses 
Item  (  per  cent,) 

Maintenance  of  way  and  structures 19.73 

Maintenance  of  equipment 22.0G 

Traffic  expenses   2.89 

Transportation  expenses   52.00 

General   expenses    3.31 

Unclassified     01 

Total    100.00 

796.  Maintenance   of  way   and   structures   involves   the   annual 
expenses  for 

a — roadway   and   track, 

b — ties, 

c — buildings,  fixtures,  and  grounds, 

d — bridges,  trestles,  and  culverts, 

e — other  track  material, 

f — superintendence, 

g — rails, 

h — miscellaneous   items   kindred   to   these. 

797.  Maintenance  of  equipment  comprises  charges  for 

a — repairs,  renewals,  and  depreciation  of  locomotives,  passenger 
and  freight  cars,  and  floating  equipment, 
b — superintendence, 
c — shop  machinery  and  tools, 
d — miscellaneous. 

798.  The  principal  items  of  traffic  expenses  are 
a — outside    agencies, 

b — superintendence, 
c — advertising, 
d — stationery  and  printing. 

Traffic  expenses  bear  such  a  small  percentage  to  the  whole  that 
they  need  no  careful  scrutiny. 


268  RAILROAD  BONDS 

799.  Transportation  expenses,  on  the  other  hand,  are  the 
heaviest  of  all  six  divisions.     They  include 

a — salaries  and  wages  of  train  and  yard  men, 
b — fuel  and  other  supplies  for  rolling  stock, 
c — expenses   of  communication   by   signal,   telephone,   and    tele- 
graph, 

d — loss  and  damage  by  freight,  and  injuries  to  persons, 
e — other  expenses. 

800.  The  general  expenses,  relatively  light,  pertain  to  adminis- 
tration, insurance,  legal  matters,  etc. 

•  •••••• 

801.  The  fact  that  railroading  is,  in  essence,  transportation,  or 
movement,  and  that  therefore  a  large  part  of  its  own  property  is 
always  in  motion,  or  directly  aiding  and  supporting  motion,  at- 
taches an  importance  to  the  maintenance  account  that  is  lacking 
to  the  maintenance  account  of  gas  or  water  companies,  or  water 
power  companies,  which  have  no  corresponding  wear  and  tear  to 
their  equipment. 

802.  The  Maintenance  Items.  Those  who  intend  to  study 
operating  expenses  will  go  directly  to  the  report  or  to  the  state- 
ment submitted  to  the  Commission,  in  which  each  item  is  minutely 
subdivided.  The  classification  of  operating  expenses  of  large  roads 
provides  for  123  primary  accounts.  But  the  synopsis  given  above  will 
show  that  the  object  sought  in  examining  operating  expenses  at  all 
is  best  found  in  the  two  Maintenance  accounts,  Maintenance  of  Way 
and  Maintenance  of  Equipment.  They  have  an  interest  for  us  far 
exceeding  that  of  the  Traffic,  Transportation,  or  General  accounts, 
because  there  is  far  greater  opportunity  to  skimp  or  surcharge  ex- 
penditures upon  the  road  and  rolling  stock,  than  there  is  upon 
wages,  salary,  insurance,  etc.  Current  building,  and  the  replace- 
ment of  old  stock  with  new  and  superior,  may  be  postponed  if  re- 
trenchment is  called  for;  but  men  must  be  paid  at  pretty  much  the 
same  rate  in  good  and  in  hard  times,  and  the  number  that  can  be 
laid  off  or  discharged  is  a  small  part  of  the  whole  (about  10  per 
cent.),  and  at  best  receives  inferior  wages.  25  to  30  per  cent,  of 
maintenance  may  be  withheld  for  a  period,  but  hardly  more  than 
12  to  15  per  cent,  may  be  cut  from  the  conduct  of  transpor- 
tation. 

803.  Or,  as  far  as  the  past  is  concerned,  when  business  has  been 
good,  equipment  may  have  been  purchased  and  charged  to  operation, 
and  work  that  is  entirely  extension  may  have  been  undertaken  on 


EARNING  POWER  AND  THE  INCOME  ACCOUNT      269 

a  scale  that  properly  demands  a  charge  to  capital  account,  but  this 
charge  also  may  have  been  put  under  operating  costs,  and  thus 
have  concealed  true  earnings.  We  look  therefore  to  the  mainte- 
nance items  for  the  clearest  sign  of  the  policy  of  the  man- 
agement. 

804.  It  is  to  the  everlasting  credit  of  American  railroading  that 
of  late  years  the  maintenance  accounts  have  been  surcharged. 
Herein  our  policy  is  distinguished  from  the  British,  which  capital- 
izes almost  every  expenditure  not  in  ordinary  course  of  business 
operation.  As  the  result  English  roads  do  business  on  weakly 
extended  credit.  Their  borrowing  capacity  is  small.  But  the  credit 
of  American  roads  is  constantly  bettering,  and  their  gross  earnings 
are  an  increasing  percentage  of  their  net  capital. 

805.  Now,  however,  the  Interstate  Commerce  Commission  takes 
the  stand  that  the  accounting  interests  of  the  management  and  of 
the  investor  are  not  at  one  with  those  of  the  public.  This  matter 
properly  comes  in  the  discussion  of  the  capital  account.  Its  rela- 
tion to  maintenance  is  that  these  charges  should,  in  the  future, 
more  truly  portray  expenditures  that  are  actually  maintenance,  in 
order  that  the  word  maintenance  may  not  be  a  misnomer.  Ex- 
penditures that  are  fundamentally  capital  shall  hereafter  be  ac- 
credited to  capital. 

806.  In  comparing  present  with  past  maintenance  accounts,  one 
ought  not  forget  the  increased  cost  of  material  commodities  and 
labor  in  this  country,  and  make  the  necessary  allowance  for  the  de- 
creased purchasing  power  of  present  appropriations. 

807.  Maintenance  of  Way.  It  is  not  necessary  here  to  enlarge 
upon  the  two  maintenance  accounts.  The  Maintenance  of  Way  is 
the  more  important  since  it  gives  greater  play  to  the  management's 
policy.  The  amount  of  this  maintenance  per  mile  is  affected,  but 
not  determined,  by  the  traffic  density.  In  comparison,  a  density  on 
one  road  of  twice  that  on  another  would  by  no  means  imply  a 
double  maintenance  of  way.  Maintenance  is  somewhat  affected  by 
mileage  earnings  also,  but  largely  on  the  principle  that  it  pays 
to  put  back  a  definite  portion,  say  30  or  35  per  cent.,  of  what  is 
taken  out. 

808.  Maintenance  of  Way  is  more  directly  affected  by  the  amount 
of  extra  track  and  the  nature  of  this  track ;  whether  it  is  extra 
main  track,  or  passing  track,  or  sidings.  The  topography  of  the 
country  is  a  very  important  factor,  for  heavy  grades,  many  curves 
and  bridges,  and  storm-swept  stretches  are  serious  burdens  in  the 


270  RAILROAD  BONDS 

annual  budget.  Flat,  open,  sparsely  settled  country,  with  its  long 
freight  hauls  on  single  track,  and  scant  passenger  business,  implies 
a  minimum  of  upkeep  which  is  impossible  in  suburban  territory, 
with  its  preponderant,  two  to  four-track  passenger  business,  fre- 
quent stops,  expensive  stations,  and  manj^-tracked,  busy  termi- 
nals. In  other  words,  to  judge  maintenance  we  must  know  the 
property. 

809.  Because  of  such  conditions  as  these  it  is  held  that  the  cost 
to  maintain  a  Southern  or  Western  single  track  road  approximates 
$1,000  a  mile,  whereas  about  $1,500  is  necessary  per  mile  of  single 
main  track  for  trunk  lines. 

810.  Even  when  we  have  made  all  proper  allowance  for  physical 
conditions,  and  are  prepared  to  compare  two  or  more  roads 
on  a  mileage  basis,  we  must  allow  again  for  any  past  difference 
in  accounting  methods:  for  in  cases  in  which  extensions 
have  been  capitalized,  or  financed  from  special  improvement 
accounts,  the  burden  of  maintenance  ought  to  be  lighter  than 
otherwise. 

811.  Maintenance  of  Equipment.  In  comparing  the  equipment  ac- 
counts of  two  roads,  apart  from  any  other  items  of  operating  ex- 
penses, such  minor  costs  as  "  shop  machinery  and  tools  "  may  be  neg- 
lected or  prorated  among  the  locomotive  and  car  units.  The  in- 
vestor must  remember,  too,  that  the  railroads  have  not  been  held  to 
uniform  charges  for  the  depreciation  of  equipment,  therefore  the 
fairest  way  in  comparison  is  to  omit  these  also,  or  else  reduce  them 
to  a  common  percentage. 

812.  The  relation  of  the  various  types  of  traffic  to  Maintenance 
of  Equipment  is  somewhat  perplexing.  The  cost  and  upkeep  of  coal 
and  ore  cars,  and  flat  cars,  is  less  than  that  of  box  cars,  which 
carry  a  higher  class  of  freight.  But,  on  the  other  hand,  it  requires 
greater  density  of  traffic,  and  therefore  greater  maintenance  of 
equipment,  to  get  the  same  operating  revenue  from  low  grade  freight 
as  from  high  grade. 

813.  Traffic,  Transportation,  and  General  Expenses.  The  three  items 
of  operating  expenses  that  remain  comparatively  fixed,  are  Traffic, 
Transportation,  and  General  Expenses.  Prior  to  1007  these  three 
charges,  with  Expenses  of  Outside  Operations,  were  under  the  head 
of  Conducting  Transportation,  General  Expenses,  etc.  By  regroup- 
ing, one  can  make  comparison  with  past  years. 

814.  Traffic  and  General  Expenses,  the  elements  of  which  have 
been  outlined,  are  such  a  small  part  of  this  group,  and  are  such  a 


EARNING  POWER  AND  THE  INCOME  ACCOUNT      271 

constant  quantity  under  varying  business  conditions,  that  they  may 
be  passed  without  further  comment. 

815.  Transportation  Expenses,  comprising  about  half  of  all  op- 
erating expenses,  are  worthy  of  careful  study.  This  account  is  in 
closest  touch  with  the  immediate  cost  of  shipment  and  train  move- 
ment. Therefore  it  should  be  reduced  to  a  mileage  basis.  The 
greater  the  traffic  density,  the  heavier  the  engine  and  train  mileage, 
and  the  train  and  carload.  Therefore,  so  far  as  transportation  ex- 
penses can  vary,  they  move  with  the  rise  and  fall  of  traffic 
density. 

816.  But  as  respects  Operating  Revenues,  they  are  almost  a  fixed 
charge,  and  precede  in  point  of  time  the  payment  of  taxes,  and  in 
point  of  law  as  well  as  time,  the  payment  of  interest.  The  amount 
remaining  after  payment  of  Traffic,  Transportation,  and  General 
Expenses,  Taxes,  Interest,  and  Rentals,  determines  the  degree  of 
liberality  with  which  the  maintenance  accounts  may  be  kept  up, — 
fattened  against  the  famine  of  coming  lean  years. 

817.  Comparisons  of  what  may  be  called  the  Transportation 
Ratio,  or  Ratio  of  Transportation  Expenses  to  Operating  Revenues, 
are  perfectly  valid  between  roads  carrying  the  same  kind  of  traffic. 
A  low  ratio  indicates  either  efficiency  of  operation  or  high  rates,  or 
both.  The  average  ratio  of  all  roads  for  the  fiscal  year  1908  was 
about  36  per  cent. 

818.  The  Operating  Ratio.  The  relation  that  Operating  Expenses 
in  their  entirety  bear  to  Gross  Earnings  is  called  the  Operating 
Ratio.  It  is  commonly  viewed  as  an  index  of  operating  economy, 
but  its  value  for  any  purpose  is  small.  Other  things  being  equal, 
a  low  ratio  is  preferable  to  a  high;  but  the  figure  is,  or  has  been, 
largely  a  booking  accident,  depending  on  the  liberality  of  the 
maintenance,  and  whether  improvements  come  from  Operating 
Expenses  or  from  Surplus.  A  low  Operating  Ratio,  however,  does 
not  necessarily  mean  a  skimping  of  maintenance;  it  may  mean 
simply  a  dense  traffic  at  good  rates,  resulting  in  heavy  mileage 
earnings. 

For  the  curious  it  may  be  stated  that  the  Operating  Ratio  of  all 
interstate  roads,  considered  as  a  system,  was  somewhat  less  than 
70  per  cent,  in  1908. 

819.  Net  Operating  Revenue.  The  third  item  in  the  Income  Ac- 
count, the  residue  after  Operating  Expenses  have  been  deducted 
from  Operating  Revenues,  is  officially  called  Net  Operating  Revenue, 
but  vulgarly,  Net  Earnings.    To  be  more  exact,  Net  Earnings  com- 


272  RAILROAD  BONDS 

monly  includes  Net  Revenues  from  Outside  Operation,  if  there  are 
any  such.  An  historical  comparison  of  Net  Earnings,  either  in  sum 
or  per  mile  operated,  is  misleading  except  after  an  analysis  of  the 
.Maintenance  charges,  because  these,  we  have  found,  are  elastic  ac- 
counts, and  can  be  surcharged  or  curtailed,  according  to  the  needs 
of  the  road  or  the  policy  of  its  management. 

820.  There  is  a  special  temptation  to  skimp  maintenance,  or 
"  skin  the  road  "  as  it  is  called,  when  gross  revenues  are  declining 
in  a  period  of  business  depression.  By  so  doing  the  showing  of  the 
Net  Revenue  may  be  upheld.  There  is  some  natural  lessening  of  all 
operating  costs  when  the  movement  of  traffic  falls  off.  But  ordi- 
narily, unless  the  maintenance  accounts  have  been  surcharged  in 
good  years,  they  should  not  decline  in  greater  ratio  than  gross 
earnings  in  poor  years,  simply  to  bolster  a  diminishing  Net 
Revenue. 

821.  Although  Net  Operating  Revenue  represents,  in  theory,  the 
profit-producing  power  of  the  railroad  as  a  carrier,  yet  there  are 
two  other  accounts  that  contribute  to  the  total  revenues  and  help  to 
pay  expenses:  Revenues  from  Outside  Operations,  and  Other  In- 
come. 

822.  Outside  Operations.  Outside  Operations  (revenues,  expenses, 
and  net)  are  sufficiently  described  by  the  Commission:  "  Previous 
reports  have  included  the  revenues  and  expenses  of  outside  operations 
in  the  general  rail  statement.  By  outside  operations  are  meant 
operations  which  are  undertaken  by  the  carriers,  but  which  are  not 
directly  incident  to  transportation  by  rail,  the  inclusion  of  which 
with  railway  transactions  would  impair  the  accuracy  of  statistical 
exhibits."  Objects  of  outside  operation  are  grain  elevators,  storage 
warehouses,  restaurant  and  hotel  systems,  etc.,  etc. 

823.  In  the  year  1908,  Outside  Revenues  were  about  2  per  cent, 
of  the  amount  of  rail  revenues,  and  Outside  Expenses  2^  per  cent, 
of  the  amount  of  rail  expenses.  The  exclusion  from  Rail  Operations 
seems  fairly  justifiable  on  the  ground  mentioned,  although  it  cer- 
tainly causes  confusion  to  those  not  familiar  with  railroad  accounts. 
By  the  separation  we  get  a  truer  rail  operating  ratio  (just  given 
above  as  about  70  per  cent.),  because  the  outside  operating  ratio  is 
so  high, — namely  over  87  per  cent. 

824.  Total  Net  Revenue.  The  sum  of  the  Net  Revenues  from  Rail 
and  Outside  Operations  is  now  called  Total  Net  Revenue.  In  those 
roads  of  which  the  reports  formerly  included  Outside  Operations 
under  Rail,  it  strictly  corresponds  to  Net  Earnings. 


EARNING  POWER  AND  THE  INCOME  ACCOUNT      273 

825.  Taxes  Accrued.  By  Taxes  Accrued  is  meant  that  portion  of 
the  year's  taxes  which  accrues  during  the  fiscal  year.  Except  for 
new  tax  items  it  is  practically  synonymous  with  the  taxes  of  the 
fiscal  year.    Again  we  refer  to  the  Commission's  report : 

"  The  place  of  taxes  in  the  Income  Account  statements  comes  immediately 
after  the  declaration  of  the  net  revenue  from  operations.  The  amount  of  this 
payment  is  in  no  way  under  the  control  of  the  carrier,  and  for  that  reason  is 
deducted  before  arriving  at  the  figure  which  represents  the  amount  transferred 
to  the  corporation  for  the  satisfaction  of  its  contracts,  for  the  payment  of 
interest  on  its  obligations,  or  for  other  corporate  purposes.  It  should  be 
distinctly  understood  that  the  location  of  taxes  in  the  income  account  state- 
ment does  not  mean  that  taxes  are  classified  as  operating  expenses." 

This  last  sentence  is  a  reference  to  the  fact  that  "  Operating  Ex- 
penses and  Taxes "  was  a  former  common  method  of  accounting 
these  two  items. 

826.  Operating  Income.  Operating  Income  is  merely  Total  Net 
Revenue  less  Taxes  Accrued. 

827.  Other  Income.  An  analysis  of  Other  Income  will  show  that 
very  much  more  than  half  of  it  comes  from  dividends  declared  on 
stocks  owned  or  controlled.  The  other  two  largest  amounts  come 
from  interest  accrued  on  funded  debt  owned  or  controlled,  and  in- 
terest on  other  securities,  loans,  and  accounts.  This  suggests  the 
reason  why  this  item  Other  Income  has  assumed  an  importance  un- 
dreamed of  fifteen  years  ago.  It  represents  in  the  Income  Account 
what  the  Investment  Account  of  the  Balance  Sheet  represents:  a 
financial  aspect  of  the  "  community  of  interest." 

828.  When  we  learn  that  only  70  per  cent,  of  the  Gross  Corporate 
Income  (Total  Net  Revenue)  is  derived  from  operations,  and  30  per 
cent,  from  securities  owned  (plus  credit  balances  from  rentals,  profits 
from  separately  operated  properties — those  minor  things  which  com- 
pose Other  Income),  the  necessity  for  investigating  these  securities 
becomes  apparent.  We  must  come  to  some  conclusion  as  to  how 
"  fixed  "  this  other  income  is :  what  portion  of  it  can  be  trusted  to 
persist  without  dimunition  through  all  kinds  of  financial  weather; 
and  from  what  portion  there  are  good  chances  of  increase  with  the 
development  of  the  property  they  represent. 

829.  To  answer  these  questions  we  are  led  to  the  corresponding 
capital  account  in  the  Balance  Sheet:  Stocks  and  Bonds  Owned. 
A  comparison  of  the  two  accounts  gives  us  an  idea  of  the  approxi- 
mate fairness  of  the  valuation  placed  upon  Securities  Owned  in  the 
Balance  Sheet. 


274  RAILROAD  BONDS 

830.  Gross  Corporate  Income.  Gross  Corporate  Income  is  better 
known  and  accurately  described  as  Total  Net  Income.  It  is  the 
sum  of  Operating  and  Other  Income,  and  the  direct  sources  from 
which  payments  are  made  for  all  fixed  charges. 

831.  Deductions    from    Gross    Corporate   Income  :    Fixed    Charges. 

Fixed    Charges    (now   technically    called    Deductions    from    Gross 

Corporate  Income)  are  itemized  in  the  reports  to  the  Commission 

as  follows: 

Proportion  to  Total 
Operating  Revenues 
Item  (percent.),  1908 l 

Rents  accrued  for  lease  of  other  roads 21 

Hire  of  equipment — balance 4 

Joint  facilities    4 

Miscellaneous  rents    1 

Separately  operated  properties — loss 

Interest  accrued  on  funded  debt 60 

Other  interest    6 

Sinking  funds  chargeable  to  income 1 

Other  deductions    3 

Total    100 

Comparisons  of  the  fixed  charges  thus  constituted  with  the  past 
years  of  the  given  road,  or  other  roads,  may  be  somewhat  impaired 
unless  allowance  is  made  for  the  fact  that  taxes  were  frequently 
incorporated  in  this  account,  and  that  hire  of  equipment,  including 
serial  payments,  frequently  was  not.  We  shall  mention  presently 
how  comparisons  may  be  prejudiced  by  the  sinking  fund  items. 
The  discussion  cannot  have  been  followed  thus  far  without  realizing 
the  immense  service  of  the  Interstate  Commerce  Commission  to  the 
study  of  railroad  finance  in  ordering  the  accounting  items  and 
making  them  uniform. 

832.  The  degree  of  "  fixedness  "  of  the  several  items  in  the  charge 
is  varying.  If  inevitableness  has  been  the  essence  of  the  account, 
taxes  would  not  have  been  removed.  The  settlement  of  them  may 
be  delayed,  but  whatever  happens  they  must  be  paid.  Many  of  the 
rental  items,  notably  the  hire,  and  what  is  really  the  serial  payment, 
of  equipment  will  ordinarily  be  taken  care  of  before  interest.     In- 

1  The  table  of  proportions  has  been  added  to  the  Report  that  the  average  rela- 
tive importance  of  the  several  charges  may  appear. 


EARNING  POWER  AND  THE  INCOME  ACCOUNT      275 

terest,  in  turn,  will  be  met  before  appropriations  are  made  to 
sinking  funds.  A  trustee  for  bondholders  will  not  be  so  foolish  as 
to  throw  a  road  into  the  hands  of  receivers  and  break  the  price  of 
the  bonds,  simply  to  obtain  his  sinking  fund. 

833.  It  will  be  seen  that  interest  and  the  funded  and  floating 
debt  comprise  about  65  per  cent,  of  all  fixed  charges.  Interest, 
like  taxes,  rentals,  and  guarantees,  should  include  everything  ac- 
crued to  the  end  of  the  fiscal  period.  Roads  of  strong  credit  with 
old,  high-interest-bearing  issues  soon  to  mature,  or  with  notes  which 
are  to  be  turned  into  secured  loans,  have  a  prospective  saving  in 
this  account  that  is  sometimes  worth  consideration. 

834.  Rentals  of  Leased  Roads  (including  guaranteed  dividends, 
etc.)  and  Joint  Facilities  take  up  one-quarter  of  the  Fixed  Charges. 
The  importance  of  these  items  grows  with  the  consolidation  of 
companies  and  the  development  of  intercorporate  relations.  Rent- 
als of  lines  leased  from  other  corporations  represent  an  element  of 
risk  beyond  their  mere  charge  against  income.  Undertaken  to 
obtain  traffic  advantage,  usually  at  a  time  when  the  surplusage 
of  the  leased  lines  more  than  met  the  rentals  or  guarantees,  a  lessen- 
ing of  traffic  in  hard  times  may  leave  debit  balances.  The  study 
that  should  be  devoted  to  the  rental  account  of  any  road  depends  on 
the  relative  drain  of  the  item.  The  New  York  Central  spends  more 
money  annually  in  rentals  than  in  interest  on  its  funded  debt. 

835.  A  generation  ago  the  sinking  fund  item  was  no  such  trivial 
matter  as  1  per  cent,  of  the  obligatory  charges;  but  experience 
has  demonstrated  that  money  is  more  wisely  appropriated  if  it  is 
not  sequestrated  in  special  funds,  but  is  returned  immediately  to 
the  road  in  heavier  maintenance,  or  more  extensive  improvements, 
with  trust  in  the  increased  earnings  and  better  credit  thus  acquired, 
to  refund  the  issue  at  maturity  in  a  general  scheme  of  debt-con- 
solidation. But  this  does  not  apply  to  bond  issues  which  do  not 
create  property  that  can  be  charged  to  capital  account,  or  which 
do  not  create  a  permanently  greater  earning  capacity. 

836.  The  principle  does  not  apply,  moreover,  to  issues  of  public 
service  corporation  bonds  generally,  because  of  the  comparative 
uncertainty  of  their  refunding  opportunities,  due  to  a  less  firmly 
established  banking  (as  distinguished  from  commercial)  credit. 

837.  Some  roads  with  old  debts,  or  serial  loans,  viz.,  Erie,  Penn- 
sylvania, and  Burlington,  have  considerable  sinking  funds  charge- 
able to  income.  These  accounts  will  rapidly  diminish;  but  since 
they  lessen  the  interest  charge,  and  are  as  much  a  credit  as  a  debit, 


276  RAILROAD  BONDS 

they  should  be  taken  into  account  in  comparison  with  the  charges 
of  other  roads  not  so  circumstanced. 

838.  To  return  to  the  fixed  charges  as  a  whole :  a  reduction  of  these 
charges  to  a  mileage  basis  is  desirable  and  even  necessary  for  any 
proper  comprehension  of  the  annual  burden.  But  it  does  not  avail 
to  compare  two  charges  so  reduced  except  with  reference  to  gross 
and  net  earnings,  and  to  the  flexible  accounts,  Maintenance  and  Sur- 
plus.    Further  discussion  of  this  matter  involves  the  next  account. 

839.  Net  Corporate  Income.  The  deductions  of  the  various  fixed 
charges  from  Gross  Corporate  Income  (Total  Net  Income)  leaves 
the  Net  Corporate  Income,  commonly  called  Surplus.  It  is  the 
amount  placed  at  the  disposal  of  the  boards  of  directors  for  the 
payment  of  dividends  and  other  corporate  expenditures  mentioned 
in  the  Income  Account.  Surplus  may  be  defined  as  that  part  of 
the  annual  income  of  a  road  which  is  not  necessary  to  the  imme- 
diate conduct  of  the  business  or  to  the  payment  of  its  current 
obligations.  More  briefly  still,  it  is  the  difference  between  the 
curreut  income  and  the  necessary  current  outgo.  It  therefore 
represents  net  profits  after  all  business,  just  as  net  earnings  rep- 
resent net  operating  profit. 

840.  There  is  no  better  illustration  of  the  essentially  false  state- 
ments possible  in  railroad  reports  when  not  checked  by  govern- 
mental supervision  than  that  furnished  by  the  surplus  account. 
Surely  one  would  suppose  that  the  previous  items  which  determine 
surplus  were  strictly  cash  amounts.  Yet  railroads  have  reported 
surpluses  amply  sufficient  for  dividends  and  have  been  obliged  to 
borrow  money  to  pay  these  dividends,  and  to  conduct  the  business. 

841.  The  Margin  and  Factor  of  Safety.  If  gross  earnings  fall  off, 
and  operating  and  fixed  charges  do  not  correspondingly  decline, 
the  cost  of  doing  business  will  leave  a  narrower  margin  of  profit. 
As  costs  encroach  upon  profit  the  financial  position  of  the  road 
weakens.  The  surplus,  then,  or  margin  of  profit,  is  the  Margin  of 
Safety,  a  quantitative  matter,  of  small  statistical  importance  ex- 
cept in  relation  to  income,  gross  and  net.  This  relation  expresses 
the  more  important  thing,  the  Factor  of  Safety,  which  is  the  ratio 
of  this  margin  of  safety,  or  surplus,  to  the  Total  Net  Income. 
When  the  ratio  is  50  per  cent,  or  more,  the  interest  on  the  bonds 
is  considered  very  secure. 

842.  The  Factor  of  Safety,  unfortunately,  is  not  an  accurate 
index  of  safety  at  all.  To  be  sure,  in  any  one  road  a  large  factor, 
or  a  large  surplus,  is  better  than  a  small;  but,  simply  as  a  matter 


EARNING  POWER  AND  THE  INCOME  ACCOUNT      277 

of  accounting,  the  bond  interest  of  a  road  with  a  55  per  cent. 
Factor  of  Safety  may  be  less  secure  than  that  of  a  road  with  a 
45  per  cent.  Factor,  for  the  surplus  of  the  first  road  might  be  such 
a  small  proportion  of  the  gross  earnings  that  a  serious  decline  in 
traffic  might  wipe  it  out;  whereas,  assuming  that  all  charges  re- 
mained the  same,  a  similar  decline  in  gross  earnings  on  the  second 
road,  with  its  surplus  larger,  relative  to  its  gross,  might  not  ex- 
tinguish that  surplus. 

843.  All  considerations  like  this  are  purely  a  matter  of  arith-        (J* 
metic.    When  government  direction  of  railroad  affairs  has  achieved     \      t 
a  thorough  uniformity  in  accounting,  especially  in  the  two  Main-      / 
tenance  charges,  undoubtedly  a  more  significant  Factor  of  Safety         £N 
will  be  devised.  ^a 

844.  It  seems  to  the  writer  that  a  truer  factor  may  be  reasoned  * 
out  in  this  way:  The  maximum  of  business  safety  conceivable  (100 

per  cent.)  is  attained  when  there  are  no  operating  expenses  of  any 
kind.  The  Surplus  is  the  difference  between  the  total  earnings  and 
all  necessary  expenses.  It  would  be  100  per  cent,  in  the  case  of 
a  company  operating  without  any  expense. 

845.  By  necessary  expenses  are  meant  all  the  charges  that  in 
theory  at  least  are  necessary  to  the  immediate  conduct  of  the  rail- 
road business  and  to  the  payment  of  current  obligations, — i.e.  Ex- 
penses of  Rail  and  Outside  Operations,  Taxes,  and  Fixed  Charges. 
Although  Operating  Expenses  and  Taxes  are  not  altogether  of  the 
nature  of  fixed  charges,  nevertheless  they  are  obligatory,  as  stated 
previously,  and  their  payment  is  even  more  immediately  necessary 
than  the  payment  of  fixed  charges,  to  keep  the  road  from  bankruptcy. 

846.  There  would  be  no  safety  at  all  (0  per  cent.)  if  necessary 
expenses  were  equal  to,  or  greater  than,  earnings  in  any  year. 
In  other  words,  from  the  standpoint  of  the  Income  Account,  the 
Factor  of  Safety  is  0,  if  there  is  no  surplus  for  the  year,  as 
distinguished  from  accumulated  surplus.  Similarly,  if  necessary 
expenses  are  one-half  of  earnings,  Surplus  is  one-half  of  earnings 
and  the  Factor  is  50  per  cent. 

847.  The  present  Factor  of  Safety  is  a  misnomer.  The  maximum 
of  safety  is  not  reached  when  Surplus  is  the  same  amount  as  (100 
per  cent,  of)  the  Net  Earnings.  This  is  merely  the  condition  when 
the  company  has  no  fixed  charges.  All  charges  should  be  eliminated 
before  the  100  per  cent,  is  attained.  Therefore  the  Ratio  of  Sur- 
plus to  all  earnings  is  the  true  factor,  rather  than  the  ratio  of 
Surplus  to  Total  Net  Income. 


278  RAILROAD  BONDS 

848.  Any  one  who  is  making  an  independent  study  of  railroad 
reports  will  not  be  satisfied  wilh  accepting  the  amount  of  the  Sur- 
plus as  it  now  stands.  Although  the  income  statement  does  not 
readily  show  the  fact,  the  investigator  will  be  mindful  that  the 
nominal  surplus  is  the  difference  between  the  Revenues  from  Opera- 
tion and  Other  Income,  on  the  one  hand,  and  Operating  Expenses, 
Fixed  Charges,  and  Taxes,  on  the  other.  If  expenses  were  as 
accurately  tabulated  as  earnings  this  would  be  sufficient.  But  we 
have  learned  that  sometimes  there  is  an  undercharge,  and  frequently 
there  is  an  overcharge  in  the  report  of  Operating  Expenses — and 
that  most  of  the  misrepresentation  occurs  in  the  two  Maintenance 
accounts,  but  some  of  it  in  the  Transportation  account.  The  over- 
charge, or  undercharge,  is  that  sum  which  is  more  or  less,  respec- 
tively, than  sufficient  to  keep  and  run  the  property  on  a  par  with  its 
competitors  which  operate  under  like  conditions. 

849.  For  the  fiscal  year  ending  June  30,  1908  (to  which  we 
have  confined  ourselves  as  a  matter  of  convenience),  American 
operating  roads,  considered  as  a  system,  report  a  total  of  fixed  or 
semi-fixed  expenditures  of  $2,715,087,364,  and  consequently  a  sur- 
plus of  $395,902,474.1  It  is  admitted  that  American  maintenance 
charges,  as  a  whole,  are  more  than  ample.  Hence,  although  condi- 
tions for  that  year  are  more  favorable  than  may  obtain  over  a  long 
period  of  years,  the  Factor  of  Safety  obtained  from  these  figures 
may  not  be  too  low  for  a  standard.     It  is  15  per  cent. 

The  general  tenor  of  these  remarks  on  the  Factor  of  Safety  applies 
with  equal  force  to  the  income  accounts  of  public  service  and  in- 
dustrial  corporations. 

850.  Disposal  of  Net  Corporate  Income  or  Surplus.  It  is  just  as 
necessary  to  scrutinize  the  disposition  of  Surplus  Earnings  as  it 
is  any  of  the  other  accounts.  Surplus  Earnings  is  the  amount  placed 
at  the  disposal  of  directors  for  the  payment  of  the  dividends  and 
other  corporate  expenditures  mentioned  in  the  Income  Account. 
In  want  of  a  balance  there  is,  of  course,  a  deficit.  The  balance  may 
be  allotted  as  follows: 

Dividends  declared  from  current  income, 
Additions  and  betterments  charged  to  income, 
Appropriations  to  reserves  and  miscellaneous  items, 
Balance  to  credit  of  profit  and  loss. 

1  Allows  for  a  "  Net  Deficit  "  of  $1,660  in  an  account  in  which  the  gross  revenues 
and  expenses  were  not  reported. 


EARNING  POWER  AND  THE  INCOME  ACCOUNT      279 

851.  The  Report  of  the  Commission  for  1908  says:  "  In  addition 
to  the  dividends  declared  from  Current  Income,  dividends  to  the 
amount  of  $57,733,808  were  declared  out  of  the  surplus  accumulated 
from  past  years,  making  a  total  for  dividends  declared  by  operating 
companies  of  $329,062,261.  It  is  not  known  what  motives  carriers 
may  have  for  declaring  dividends  out  of  surplus  rather  than  out 
of  current  income,  but  it  is  evident  that  to  the  extent  of  the 
dividends  declared  out  of  accumulated  surplus  the  balance  carried 
forward  to  profit  and  loss  is  overstated,  if  that  amount  is  accepted 
as  the  measurement  of  the  increase  in  the  undivided  surplus  result- 
ing from  the  year's  operations." 

852.  As  to  what  part  of  surplus  should  be  spent  in  dividends,  it 
depends  on  the  method  of  booking  and  on  the  physical  condition 
of  the  property.  A  heavily-padded  maintenance  account,  and  the 
pink  of  physical  condition  are,  in  themselves,  real  reserves,  and  can 
be  drawn  on,  negatively,  by  reduction  in  charges  for  maintenance. 
If  most  betterments  and  improvements  are  drawn  directly  out  of 
surplus,  a  smaller  part  of  this  account  can  safely  be  devoted  to 
dividends. 

853.  In  the  minds  of  many,  Pennsylvania's  primacy  among  rail- 
roads is  due  to  her  old-time  policy  of  "a  dollar  for  improvements, 
for  every  dollar  of  dividends."  It  is  the  same  sort  of  policy  that 
has  placed  the  securities  of  the  United  States  Steel  Corporation 
upon  a  sound  investment  basis  within  a  few  years. 

The  railroad  companies  are  still  too  many  that  do  not  appear  to 
have  any  convictions  as  to  the  need  of  building  up  a  surplus  reserve 
in  cash  or  quick  assets  against  the  emergency  of  a  financial  crisis. 

854.  The  Appropriations  to  Reserve  and  Miscellaneous  Items 
may  need  some  division,  for  it  does  not  all  mean  equity  for  the 
bondholder.  Charges  against  the  company  that  do  not  find  con- 
venient lodgment  elsewhere  are  settled  in  bookkeeping  adjustment 
by  inclusion  under  Miscellaneous  Items. 


CHAPTER  XXII 

RAILROAD   BONDS:   VALUATION   AND   THE   CAPITAL 

ACCOUNT 

855.  From  the  bondholders'  point  of  view  it  is  not  enough  that 
a  railroad  is  well  connected,  and  efficiently  operated  and  main- 
tained, and  is  obtaining  satisfactory  rates  from  a  heavy  volume  of 
traffic.  The  Erie  is  in  this  very  position;  but  Erie  securities  do 
not  meet  with  especial  favor. 

856.  The  analysis  of  the  Income  Account  in  the  preceding  chap- 
^^         ter  left  us  with  an  idea  of  the  other  requirement  of  good  credit, 

7^      which  can  be  expressed  in  terms  of  income  as  a  sufficient  margin 
n  of  profit  above  all  necessary  or  advisable  current  expenses  to  meet 

the  mandatory  charges  of  interest,  rentals,  guaranteed  dividends, 
and  the  like.  Since  these  charges  represent  the  price  paid  for  the 
use  of  capital,  we  take  the  final  step  in  our  investment  study  when 
we  investigate  capital  itself,  both  borrowed  and  proprietary,  and 
learn  as  much  as  may  be  learned  of  the  loaned  capital  and  the 
capital  estate  in  general,  and  the  relation  the  one  bears  to  the 
other,  just  as  we  learned  the  relation  of  the  fixed  charges  (the  cost 
of  loan  capital)  to  earnings  (the  product  of  the  capital  estate). 
The  official  source  for  this  information  is  the  Capital  Account  of 
the  annual  report.  The  Capital  Account  is  the  railway's  valua- 
tion of  its  more  or  less  permanent  assets  and  liabilities. 

857.  The  Basis  of  Valuation.  Although  many  are  not  aware  of 
the  fact,  every  one  is  deeply  concerned  in  the  correctness  of  the 
railroads'  valuation.  No  one  will  gainsay  that  the  public,  and 
therefore  the  Government,  are  willing  that  American  railroads 
should  earn  a  fair  return  on  their  value.  It  is  the  public,  however, 
which  pays  this  return,  every  time  that  it  buys  a  railroad  ticket,  or 
an  article  that  has  been  on  a  freight  car.  Hence  the  public  is  begin- 
ning to  care  whether  American  railroads  are  worth  $20,000,000,000, 
or  $25,000,000,000,  or  only  $15,000,000,000. 

858.  The  Interstate  Commerce  Commission,  in  regulating  rail- 
road business  on  the  one  hand,  and  in  forming  public  opinion  on  the 

280 


VALUATION  AND  THE  CAPITAL  ACCOUNT  281 

other,  is  so  potent  that  naturally  we  first  turn  to  the  Commission  for 
an  expression  of  its  attitude  toward  railway  valuation. 

The  Commission  takes  the  stand  that  valuation  means  any  of 
three  things  according  as  we  seek  to  conserve  the  interest  of  (a) 
the  management,  (b)  the  investor,  or  (c)  the  public. 

859.  The  Commission  holds  that  it  is  the  interest  of  the  manage- 
ment to  maintain  and  increase  the  credit  of  the  property,  which  is 
accomplished  by  widening  "  the  margin  between  the  value  of  the  prop- 
erty to  which  the  corporation  has  title  and  the  amount  of  securities 
outstanding  on  the  property."  This  has  been  accomplished  in  book- 
keeping by  overcharging  expenses,  etc.,  especially  the  maintenance 
accounts.  By  so  widening  the  margin  fresh  capital  is  more  easily 
raised  in  time  of  need.  Therefore  the  management  values  the  road  in 
terms  of  securities  outstanding ;  "  and,  as  long  as  balance  sheets  are 
constructed  with  exclusive  regard  to  the  interest  of  the  management, 
it  will  not  be  possible  to  read  from  them  the  investment  cost  of 
the  property." 

860.  But  "  the  interest  of  the  stockholder  ...  so  far  as  the  ac- 
counting record  of  charges  to  property  accounts  is  concerned,  is  at 
variance  with  that  of  the  management.  .  .  .  The  stockholder  is  the 
residuary  proprietor  of  all  the  company's  assets  not  covered  by 
outstanding  obligations,  and  it  is  to  his  interest  that  the  value  of 
the  property  should  be  increased  without  a  corresponding  increase 
in  the  number  of  shares  which  have  a  proprietary  claim  upon  thej 
property.  .  .  .  The  stockholder's  interest  is  expressed  in  valuation. 

.  .  .  He  desires  also  to  have  as  high  a  statement  of  the  property 
accounts  as  the  commercial  conditions  of  the  business  warrant,  in 
order  that  he  may  protect  the  value  of  his  investment  by  showing 
how  great  is  the  value  of  the  property  used  in  rendering  the  service 
for  which  the  public  pays." 

861.  "  The  interest  of  the  public  .  .  .  rests  upon  the  fact  that 
a  reasonable  rate  for  transportation  services  is  a  rate  which  con- 
tributes a  reasonable  return  upon  necessary  investments,  and  a 
satisfactory  balance  sheet  from  the  public  point  of  view  is  one 
which  shows  what  has  been  actually  invested  in  the  property.  The 
public,  therefore,  has  the  right  to  demand  that  the  property  ledger 
should  record  every  item  of  property  which  an  appraiser  would 
find,  should  an  appraisement  be  undertaken,  and  from  the  point  of 
view  of  the  public  at  least,  the  figures  entered  upon  the  property 
ledger  against  the  several  items  of  property  there  recorded  should 
be  the  amount  of  money  actually  spent  in  creating  the  property, 


/ 


282  RAILROAD  BONDS 

rather  than,  as  the  management  desires,  the  amount  of  securities 
issued,  or,  as  the  stockholder  desires,  the  commercial  valuation  of 
the  property." 

862.  In  summary,  the  interest  of  the  management  is  to  keep  the 
capitalization  down;  but  of  the  stockholder  (here  made  representa- 
tive of  investing  interests)  to  put  the  commercial  valuation  up; 
and  of  the  public,  to  have  as  valuation  "  the  money  actually  spent 
in  creating  the  property." 

869: — The  Commission  naturally  sympathizes  with  the  interest  of 
the  public;  and  therefore,  under  an  order  of  June  21,  1909,  has 
issued  a  form  of  General  P.alance  Sheet  statement  which  is  hoped 
to  show  an  "  investment "  or  original-cost  valuation  of  railroad 
property.  The  result  of  this  step  is  that  future  balance  sheets 
cannot  be  compared  with  those  of  the  past  without  more  careful 
dissection  than  most  people  care  to  attempt.  But  the  loss  will 
more  than  be  made  up  by  the  uniformity  in  statement  which  will 
govern  hereafter,  making  possible  valid  comparisons  of  a  company's 
future  annual  statements,  and  of  the  future  statements  of  one 
company  with  another.  As  statements  have  been,  with  no  informing 
principle,  prima  facie  comparisons  of  two  or  more  companies  for 
the  same  years  have  usually  been  almost  worthless. 

884.  In  the  opinion  of  the  writer  the  three  interests  described 
are  not  so  much  at  variance  as  might  be  thought  from  the  wording 
of  the  commission's  report. 

865.  Does  the  public  believe  that  railroad  managements  have 
endeavored  to  keep  nominal  capitalization  below  true  property 
value?  One  of  the  great  railroad  companies  not  so  very  many  years 
ago  declared  a  stock  dividend  of  100  per  cent.  This  necessitated  a 
doubling  of  the  Capital  Stock  item  in  the  Liabilities.  To  offset 
this  in  the  Assets  the  management  increased  the  item  Cost  of  the 
Road  by  as  many  millions  as  the  stock  dividend.  There  is  very  much 
point  in  this  as  an  argument  against  the  old  time  balance  sheet, 
but  hardly  any  against  concealed  equities. 

866.  It  is  at  variance  with  the  fundamental  principles  of  this 
work  to  represent  in  the  stockholder  the  "  interest  of  the  investor." 
The  stockholder  is  the  railroad  speculator,  per  excellence.  The 
true  investment  interest  in  railroads  is  the  bondholder's  interest. 

867.  But  be  that  as  it  may,  have  not  all  security  holders  very 
much  the  same  interest  as  the  management,  in  the  method  of 
valuation?  Of  the  management  the  Commission  says:  "The  chief 
aim  of  those  who  administer  the  property  is  to  maintain  the  credit 


VALUATION  AND  THE  CAPITAL  ACCOUNT  283 

of  the  business  placed  in  their  hands."  Why  do  they  wish  to  main- 
tain this  credit?  To  get  more  capital  when  advisable,  and  on  good 
terms.  From  whom?  From  bondholders  and  stockholders,  old  and 
new.  And  what  do  security  holders  demand  in  return  for  money 
invested  or  speculated  in  the  property?  As  wide  as  possible  a 
"  margin  between  the  value  of  the  property  .  .  .  and  the  amount  of 
securities  outstanding  against  the  property  " — just  what  the  Com- 
mission says  the  management  wants  to  show. 

868.  Whether  or  not  the  interests  of  management  and  investor 
are  identical,  there  can  be  no  question  that  a  part  of  the  public 
thinks  its  interest  is  different.  The  Commission  has  not  endeavored 
to  prove  that  the  interest  of  the  management  or  of  the  investor  is 
not  for  the  good  of  all,  or  that  what  the  public  thinks  is  its  interest 
really  makes  for  equitable  dealing.  The  Commission,  as  the  servant 
of  the  public,  merely  purposes  to  have  future  balance  sheets  record 
what  a  large  part  of  the  public  now  demand :  "  the  amount  of  money 
actually  spent  in  creating  the  property,  rather  than,  as  the  man- 
agement desires,  the  amount  of  securities  issued,  or,  as  the  stock- 
holder desires,  the  commercial  valuation  of  the  property." 

869.  A  retroactive,  original-cost  valuation  is  manifestly  unjust, 
for  it  would  deprive  the  railroads  of  their  share  of  advantage  in 
the  general  uplift  of  property  values  due  to  our  great  growth  in 
prosperity,  and  in  the  particular  uplift  in  the  territories  they  serve 
which  they  have  foreseen,  anticipated,  and  helped  to  produce. 

870.  Replacement  valuation  is  unfair,  for  it  neglects  the  original, 
and  perhaps  now  unknown,  cost  of  experiment  and  the  assumption 
of  risk  that  were  antecedent  and  necessary  to  the  acquisition  or 
construction  of  the  physical  property.  It  is  said  that  the  under- 
taking of  the  great  Pennsylvania  terminal  in  New  York  really 
caused  the  death  of  President  Cassatt.  It  is  said,  also,  that  the 
engineering  difficulties  of  the  Lucin  Cut-off,  in  the  Great  Salt  Lake, 
nearly  proved  unsurmountable,  and  risked  the  loss  of  many  mil- 
lions that  already  had  been  spent  on  the  chance  of  successful  out- 
come. 

871.  Physical  valuation  is  unfair  because  it  is  merely  physical 
valuation;  because  it  does  not  represent  in  terms  of  capital  the 
intangible,  but  none  the  less  necessary  or  esteemed  property,  called 
"  rights,"  "  franchises,"  "  contracts  of  lease,"  etc.  Referring  merely 
to  the  legitimate  relations  between  the  legislature  and  the  corpora- 
tion,— are  franchises  always  to  be  had  for  the  asking?  The  value 
of  a  lease  to  the  lessee,  at  the  time  of  making,  was  expressed  ap- 


284  KAILROAD  BONDS 

proximately  by  the  rental  paid  or  the  dividend  guaranteed.  It  prob- 
ably had  no  relation  to  the  original  cost,  and  possibly  little  rela- 
tion to  the  cost  of  physical  replacement,  if  it  had  been  possible  to 
ascertain  either.  The  lessee  did  not  lake  the  lease  as  an  investment 
in  real  estate  or  commodities,  but  to  check,  eliminate,  or  avoid 
competition  that  probably  was  wasteful,  or  to  modify  the  character 
of  its  traffic  in  order  to  improve  the  carload,  or  for  one  of  a 
hundred  different  reasons  that  may  imply  perfectly  good  railroading. 

872.  The  cost  of  replacement  value  might  easily  be  more  than 
the  lease  value.  It  is  not  to  the  point  that  an  independent  feeder, 
running  through  sparsely  settled  lands  from  coal  fields,  cost  $15,000 
a  mile  to  build,  if  the  coal  veins  petered  out.  If,  after  such  an 
event,  the  feeder  were  bought  for  its  earnings,  the  price  paid  would 
bear  a  closer  relation  to  the  income  account  than  to  the  first  cost* 
of  the  feeder.  Or,  on  the  other  hand,  the  feeder  might  be  leased 
for  more  than  its  originated  earnings  ever  would  justify,  if  it  were 
wanted  for  its  strategic  position,  as  the  beginning  of  a  longer  line 
to  reach  richer  land  beyond. 

873.  But  furthermore,  the  value  of  the  leased  line  may  now  be 
distinctly  different  from  what  it  was  when  the  line  was  acquired. 
The  capitalization  of  rental  would  not  show  this.  The  difference 
between  the  capitalization  of  rental  and  the  company's  valuation, 
in  the  balance  sheet,  of  the  securities  of  this  leased  line,  might  be 
somewhat  of  a  guide  to  the  change  in  value  to  the  lessor. 

874.  What  is  true  of  the  capitalization  of  leases  or  leased  lines 
applies  equally  to  all  tangible  or  intangible  property  of  the  lessor 
company.  To  invalidate  the  capitalization  of  earning  power,  or 
strategic  advantage,  because  the  cost  or  physical  replacement  value 
is  less  would  be  a  confiscatory  act.  The  capitalization  of  earning 
power,  rather  than  mere  first  cost,  has  made  possible,  to  be  sure, 
great  speculative  gains;  but  these  gains  have  been  necessary  to 
attract  capital  to  the  speculative  risks  of  the  business.  Railroad 
financing  has  been  hazardous,  even  disastrous;  it  has  required 
elemental  courage  of  its  promoters  until  well  within  the  memory 
of  all  of  us.  The  capitalization  of  earning  power  has  been  at  the 
foundation  of  railroad  finance  and  of  railroad  values.  If  interstate 
railroading  has  reached  the  investment  stage,  it  seems  reasonable 
that  hereafter *  companies  should  be  required  to  show  "  investment 

1  As  a  matter  of  fact  the  carriers  are  required  to  show  "  investment  cost "  of 
all  property  acquired  since  June  30,  1910,  that  is  classifiable  as  Road  and  Equip- 
ment, or  Additions  and  Betterments,  less  deductions  for  property  abandoned. 


VALUATION  AND  THE  CAPITAL  ACCOUNT  285 

cost "  for  new  construction.  This  appears  to  be  the  attitude  of  the 
Commission  in  promulgating  the  new  balance  sheet  statement. 
Statistically,  of  course,  there  is  immense  gain,  not  only  in  the  result- 
ing uniformity  of  this  account,  but  from  the  greater  veracity  neces- 
sary in  the  returns. 

875.  The  Balance  Sheet.  The  General  Balance  Sheet  is  the  state- 
ment of  the  company's  valuation  of  its  assets  and  liabilities.  These 
sheets,  which,  as  we  said,  have  varied  greatly  in  their  composition, 
will  now  exhibit  accounts  as  follows : 

Assets —  Liabilities — 

Property  Investment,  Stock, 

Working  Assets,  Mortgage,  Bonded,  and 

Accrued  Income  Not  Due,  Secured  Debt, 

Deferred  Debit  Items,  Working  Liabilities, 

Profit  and  Loss.  Accrued  Liabilities  Not  Due, 

Appropriated  Surplus, 
Profit  and  Loss. 

876.  Since  the  Government  has  issued  a  pamphlet  explanatory  of 
these  accounts,  it  is  necessary  here  only  to  expound  the  main 
principles  upon  which  the  valuations  are  based.  Assets  and  lia- 
bilities are  always  properly  divided  into  Capital  and  Current.  In 
relating  valuation  to  earnings  the  Capital  items  are  so  much 
more  important  than  the  Current  that  we  may  properly  confine  our- 
selves to  them.  The  item  Property  Investment  is  the  only  Capital 
Asset  as  here  divided,  (a)  Stock,  and  (b)  Mortgage,  Bonded,  and 
Secured  Debt  are  the  Capital  Liabilities,  as  set  forth  above. 

877.  Property  Investment.  The  main  items  in  the  property  ac- 
count are  Road  and  Equipment,  Securities,  and  Miscellaneous  In- 
vestments. The  Cost  of  Road  and  equipment  may  have  meant  little, 
as  we  have  illustrated.  These  items  have  been  the  dumping  ground 
for  offsets  to  Capital  or  Current  Liabilities  that  it  was  not  con- 
venient to  detail.  But  since  roads  are  now  required  to  exhibit 
actual  costs  of  all  road  and  equipment  acquired,  or  General  Expend- 
itures made,  since  1907,  future  alterations  of  these  accounts,  from 
year  to  year  invite  investigation  of  the  causes  and  amounts  ex- 
pended, and  the  source  of  the  funds;  whether  a  sale  of  securities 
or  a  withdrawal  from  accumulated  surplus. 

878.  An  item  of  Capital  Assets  hitherto  more  significant  is  that  of 
Securities  Owned,  whether  held  in  the  treasury  as  investment,  and 
carried  at  cost  or  book  value,  or  pledged  in  loan  and  carried  at  par. 


I'm;  RAILROAD  BONDS 

These  securities  represent,  for  the  most  part,  the  issues  of  other 
companies  bought  for  one  or  more  of  the  various  purposes  that 
may  actuate  one  company  to  acquire  an  interest  in  another.  By 
capitalizing  on  their  merits  the  several  items  of  Other  Income  (in  the 
Income  Account)  that  are  derived  from  this  capital  item  of  Securi- 
ties Owned,  one  forms  a  fair  estimate  of  the  value  of  these  assets. 
But  such  a  mathematical  valuation  may  not  be  entirely  just  to  the 
railroad,  for  Securities  Owned  probably  have  a  value  to  it  other 
than  that  of  an  investment,  other  than  that  relating  to  dividend 
and  interest  payments.  They  have  an  indirect  earning  power 
concealed  in  the  gross  earnings.  Stock  ownership,  for  example,  may 
imply  control  of  the  line  with  resulting  diversion  of  traffic  to  the 
leasing  company. 

879.  Miscellaneous  Investments  ordinarily  is  not  an  important 
account.  But  if  a  railroad  has  a  large  proprietary  interest  in  mines, 
manufactures,  or  business  property,  that  is  not  represented  by  se- 
curities, but  by  direct  ownership,  then  some  attention  should  be 
given  the  account. 

880.  The  investor  need  give  comparatively  little  attention  to  Cur- 
rent Assets,  other  than  to  note  whether  the  railroad  carries  satis- 
factory balances  in  cash  and  virtually  liquid  funds  relative  to  its 
needs. 

881.  Capitalization.  The  capital  liabilities  are  the  various  classes 
of  stocks  and  bonds  issued  or  assumed  by  the  company.  The  total 
par  value  of  these  securities  (and  the  receiver's  certificates,  if  any) 
will  give  the  nominal  capitalization  of  the  road.  All  the  capitaliza- 
tion, like  all  the  income,  figures,  should  be  reduced  to  a  mileage 
basis  for  purposes  of  comparison,  either  with  past  years  or  with 
other  roads. 

882.  But  in  addition  to  these  items,  some  sort  of  liability  valua- 
tion must  be  put  on  the  rentals  of  various  subsidiaries  that  have 
been  leased  and  are  directly  operated,  but  the  securities  of  which 
are  not  included  among  the  capital  liabilities;  for  the  earnings  of 
these  lines  swell  the  Income  Account  of  the  lessor,  and  therefore 
the  true  capital  account  of  the  lessor  must  have  its  corresponding 
item.    This  is  generally  called  the  capitalization  of  rentals. 

883.  There  would  be  no  point  in  basing  this  capitalization  on 
the  face  value  of  the  stocks  and  bonds  of  the  subsidiaries,  because 
the  leases  were  probably  not  drawn  on  such  a  basis,  but  rather  on 
earning  power.  At  any  rate  since  we  seek  the  approximately  cor- 
rect capitalization  of  the  parent  road  to  relate  it  to  the  road's  earn- 


VALUATION  AND  THE  CAPITAL  ACCOUNT  287 

ing  power,  we  charge  the  parent  road  with  the  rental  cost  of  sub- 
sidiaries capitalized  at  some  rate  per  cent. 

884.  Often  the  rentals  are  not  on  a  percentage  basis  at  all ;  some- 
times the  percentage  is  based  on  gross  or  net  earnings  from  the  sub- 
sidiary lines;  sometimes  the  percentage  is  graded  to  scale,  over  a 
period  of  years.  But  even  when  the  rental  is  a  definite  amount  it 
is  not  always,  if  generally,  possible  to  learn  what  were  the  capitali- 
zation bases  which  originally  determined  the  amount.  For  intensive 
study  it  is  better  to  use  the  percentage  employed  by  the  company, 
when  that  is  known.  But  for  broad  comparisons  a  fixed  percentage 
for  all  rentals,  approximately  the  average  rate,  will  give  better  re- 
sults.   This  may  be  4£  or  5  per  cent. 

885.  Net  Capitalization.  By  adding  the  amounts  of  the  capital 
stock,  the  funded  debt,  and  the  rentals  capitalized,  we  have  approxi- 
mated the  gross  capitalization  of  the  road.  The  significance  of 
capitalization  is  the  relation  it  bears  to  earning  power.  To  the  ex- 
tent that  the  asset  Securities  Owned  contributes  to  income,  it 
should  be  deducted  from  the  gross  capitalization  to  attain  the  in- 
tegrity of  the  ratio  of  earnings  to  capital,  for  the  income  it  yields 
has  no  corresponding  capital  liability.  Gross  capitalization  then, 
less  the  true  "  investment  value "  of  Securities  Owned,  yields  Net 
Capitalization. 

886.  The  Relation  of  Income  to  Capital.  A  Margin  or  Factor  of 
Safety  may  show  certain  relations  between  expenses,  earn- 
ings, and  capital,  in  so  far  as  these  items  manifest  themselves  in 
the  Income  Account. 

In  the  Income  Account  capital  appears  in  the  form  of  fixed 
charges  and  dividends.  The  relation  of  Income  to  Capital  is  in- 
directly expressed  in  the  Income  Account  by  some  form  of  Margin 
or  Factor  of  Safety.  In  the  Factor  of  Safety  we  refer  primarily  to 
the  safety  of  the  fixed  charges.  Therefore  the  Factor  of  Safety,  as 
commonly  understood,  is  of  more  immediate  interest  to  the  bond- 
holder than  to  the  stockholder. 

887.  In  the  Capital  Account  several  relations  between  earnings 
and  liabilities  might  well  be  expressed;  but  that  of  most  interest, 
not  only  to  the  bondholder,  but  to  all  owners  of  the  road's  securities 
or  others  interested  in  its  welfare,  is  the  ratio  that  Net  Income 
bears  to  Net  Capitalization.  Net  Income  x  is  the  residue  after  de- 
duction of  all  expenses  except  the  fixed  charges.     Operating  Ex- 

1  Net  Income  is  used  here  in  its  ordinary  signification:  as  synonymous  with 
**  Gross  Corporate  Income,"  rather  than  with  "  Net  Corporate  Income." 


288  RAILROAD  BONDS 

penses,  therefore,  have  been  taken  into  consideration  when  we  de- 
termine the  Ratio  of  Net   Income  to  Net  Capital. 

888.  The  Income  Ratio  just  described  becomes  highly  significant 
of  the  high  or  low  "investment"  capitalization  per  mile.  There 
is  some  slight  meaning  to  the  statement  that  a  certain  line  is  capital- 
ized at  |30,()()()  per  mile,  let  us  say,  for  if  it  is  of  standard  steam 
construction  we  know  that  under  most  advantageous  conditions  this 
capitalization  represents  money  expended,  and  undoubtedly  less 
than  the  full  sum  expended.  Cost  and  physical  replacement  value 
from  this  time  on  are  likely  to  affect  railway  capitalization  more 
than  they  have  in  the  past,  therefore  Absolute  Capitalization  has 
its  place  in  railroad  stud}7.  But  Investment  Capitalization,  or  the 
stock  and  funded  debt,  etc.,  per  mile,  in  relation  to  Net  Income  is 
the  index  of  financial  competency,  just  as  the  true  Factor  of  Safety 
is  the  index  for  any  one  year. 

889.  The  Relation  of  Funded  Debt  to  Capitalization.  It  is  not 
enough  to  know  the  relation  of  Net  Income  to  Net  Capitalization. 
Although  all  capitalization  is  bookkeeping  liability,  only  Funded 
Debt  and  Capitalized  Rentals  are  obligatory;  Capital  Stock  is  not. 
The  greater  the  amount  of  debt,  in  comparison  with  property  value, 
the  less  safe  is  the  property  and  everything  connected  with  it. 
Issues  of  new  stock,  in  these  days,  usually  represent  cash  put  into 
the  property.  Since  stock  is  frequently  offered  at  a  premium,  the 
money  obtained  may  be  inadequately  represented  by  the  mere  in- 
crease in  stock  capitalization. 

890.  However,  a  study  of  Income  Ratio  should  involve  a  study 
of  the  ratio  of  Funded  Debt  and  Rentals  Capitalized  to  Capital 
Stock.  A  G  per  cent,  income  ratio  may  be  safer,  if  bonds  are 
one-third  of  the  capitalization,  than  an  8  per  cent,  income  ratio 
when  honds  are  two-thirds  of  the  capitalization.  A  company  that 
is  lessening  the  ratio  of  its  obligations  to  its  stock  at  the  rate, 
perhaps,  of  1  per  cent,  per  annum,  may  be  improving  its  position 
more  radically  than  if  it  were  lowering  its  mileage  capitalization 
at  the  rate  of  several  per  cent,  per  annum. 

Bond  Security  as  Affected  by   Priority  of  Claim 

891.  After  examination  of  the  personnel,  the  affiliations,  and 
the  physical,  income,  and  capital  characteristics  of  the  railroad,  the 
investor  turns  to  his  bond,  to  learn  from  the  recital  on  it,  and 
then  from  the  mortgage  or  deed  of  trust  to  which  the  recital  re- 


VALUATION  AND  THE  CAPITAL  ACCOUNT  289 

fers,  what  is  the  nature  of  his  claim  against  the  railroad  if  it 
should  fail  to  honor  the  interest  or  the  principal. 

892.  The  Relative  Positions  of  the  Various  Bond  Issues.  In  pre- 
vious chapters  devoted  to  the  Classification  of  Bonds  an  effort 
was  made  to  show,  by  definition  of  a  hundred  or  so  bond  classes, 
something  of  the  position  of  an  issue  relative  to  any  of  the 
other  issues,  if  both  were  of  the  same  road.  Railroad  debt- 
structure  is  a  mysterious  and  wonderful  thing — much  more  won- 
derful than  creditable.  Precedence  of  bond  issues  is  as  delicate, 
debatable,  and  involved  as  precedence  at  a  state  dinner.  The 
only  principles  of  precedence  that  stand  out  clearly  are  those 
with  which  every  one  is  familiar.  The  secured  obligations  of  a 
corporation  are  superior  to  the  debenture;  lien  security  is  surer 
than  guaranty;  lien  on  realty  is  stronger  than  lien  on  personalty; 
realty  that  is  merchantable,  or  that  has  its  own  independent  earn- 
ing, makes  a  better  lien  than  realty  that  cannot  readily  be  sold 
or  that  has  earnings  dependent  upon  the  cohesion  of  the  entire 
property.  A  first  mortgage  has  a  better  claim  than  a  second;  a 
second  than  a  third;  primary  liens  anticipate  secondary  liens, 
and  secondary  liens  anticipate  junior  liens.1 

893.  But  even  these  general  truths  require  modification.  When 
a  first  mortgage  divisional  or  sectional  bond  is  a  direct  obligation 
of  the  parent  operating  company,  it  may  be  "  prior,"  but  never- 
theless actually  inferior  to  a  general,  consolidated,  or  refunding 
bond  that  covers  the  same  mileage  as  a  junior  lien,  but  has  a 
broader  claim  on  the  company's  earnings  and  assets  than  does  the 
divisional  first  mortgage.  But  this  exception  would  not  hold  if 
the  division  was  absolutely  essential  to  the  integrity  of  the 
property. 

894.  We  have  stated  repeatedly  that  the  debentures  of  certain 
roads  were  safer  investments  than  the  first  mortgage  bonds  of 
others.  This  is  tantamount  to  saying  that  priority  of  lien  waits 
upon  earnings.  Earnings  of  the  entire  road  are  the  real  touch- 
stone of  bond  security.  It  is  this  thought  that  underlies  the  new 
Factor  of  Safety  suggested.  Safety  depends  on  solvency.  As  long 
as  there  is  any  true  Factor  of  Safety  there  is  solvency.  WThen  a 
road  goes  bankrupt,  those  bond  issues  with  the  very  best  claim 
on  the  property — bonds  that  are  sure  to  have  their  interest  met — 
will  lose  at  least  one  element  of  safety,  i.e.  Security  in  Liquidation. 

1  The  exact  incidence  and  ranking  of  almost  all  American  railroad  mortgages 
may  be  found  in  White  and  Kemble's  Atlas  and  Digest  of  Railroad  Mortgages. 


290  RAILROAD  BONDS 

They    will    not    then    sell    at    their    intrinsic    worth    as    invest- 
ments. 

895.  If  reorganization  succeeds  bankruptcy,  and  earnings  de- 
cline to  such  a  degree  that  interest  on  a  substantial  number  of 
issues  cannot  be  paid,  an  inexperienced  bondholder  will  find  that 
priority  of  lien  in  railroad  bonds  is  quite  a  different  thing  from 
priority  in  real  estate  mortgages.  Let  us  suppose  that  this  investor 
is  one  among  a  hundred  who  have  part  interest  in  a  first  mort- 
gage covering  an  entire  division  of  the  road,  tributary  to  the  main 
line.  The  first  mortgage  bondholders,  on  examination,  find  that 
the  earnings  from  this  division  have  been  sufficient  for  a  long 
period  to  pay  the  interest  on  the  loan.  They  elect  to  exercise  their 
legal  privilege  and  foreclose.  At  the  sale  they  buy  in  their 
property  with  their  bonds  and  wipe  out  possible  stock  or  junior 
obligations  outstanding. 

896.  These  foreclosing  investors  have  now  become  speculators, 
and  on  most  unpromising  terms.  They  have  a  railroad,  while  it  is 
running;  but  after  that  some  scrap  and  a  little  real  estate.  Rail- 
roading is  a  highly  technical  business ;  and  bond  buyers,  as  a  class, 
are  not  railroad  men.  They  find  that  dismemberment  from  the 
trunk  line  cost  them  a  lot  of  traffic.  Necessary  economies  are  not 
possible  on  the  smaller  unit  of  transportation.  Their  road  lacks 
the  long-established  banking  relations,  and  the  better  known 
name.  The  sale  of  the  road  to  themselves  has  brought  no  working 
capital.  Maintenance  must  have  been  neglected  before  the  main 
road  went  under,  and  past  insufficiency  of  upkeep  now  appears  in 
heavier  operating  expenses  already  excessive  in  the  transportation 
items  because  of  comparatively  inexperienced  management. 

The  usual  result  of  this  situation  is  a  continuous  decline  in  earn- 
ings until  the  fixed  charges  can  no  longer  be  met,  and  the  bond- 
holders will  most  heartily  wish  they  hadn't  bought  the  road. 

897.  Ordinarily,  then,  continued  default  on  railroad  issues 
means  reorganization  with  capital  scaled  to  meet  earnings.  The 
mountain  in  this  case  must  come  to  Mohammed.  The  scaling  of 
capitalization  must  be  arbitrated  and  settled  on  a  basis  of  ex- 
pediency and  equity.  Priority  of  claim  will  be  recognized;  the 
underlying  liens  may  remain  untouched ;  but  let  no  first  mortgage 
bondholder  think  his  entire  wants  would  be  satisfied,  if  by  this 
satisfaction  the  junior  interests  would  be  wiped  out,  unless  it  is 
thought  the  road  and  its  prior  claimants  are  entirely  self-subsist- 
ent.     Even  the  holders  of  common  stock  are  seldom  utterly  sacri- 


VALUATION  AND  THE  CAPITAL  ACCOUNT  291 

ficed.    They  are  permitted  to  retain  an  equity,  as  it  were,  when  no 
equity  exists. 

898.  It  would  be  misleading  to  close  these  comments  on  rail- 
road bonds,  and  the  nature  of  their  security,  by  so  much  thought 
of  default  and  foreclosure.  One  has  only  to  follow  the  lines  of 
investigation  suggested  here,  to  realize  that  in  spite  of  enormous 
increases  in  capitalization — in  fact  because  of  them — the  equities 
in  American  railroads  are  rapidly  growing.  That  is  to  say,  rail- 
road bonds,  now  safe  as  a  class,  are  rapidly  growing  safer.  Every 
year  the  market  price  of  a  larger  proportion  of  them  rises  or 
falls,  not  with  the  rise  or  fall  in  earning  power,  but  with  the 
fall  and  rise  of  interest  rates.  In  the  financial  marts  their  se- 
curity is  taken  for  granted;  their  price  is  merely  a  question  of 
investment  demand. 


CHAFTER  XXIII 
EQUIPMENT  TRUST  OBLIGATIONS 

899.  Origin.  About  thirty-eight  years  ago  certain  railroads  of 
the  country  that  found  difficulty  in  meeting,  from  their  ordinary 
resources,  the  requirements  of  increasing  traffic  and  territorial 
expansion,  conceived  a  new  method  for  financing  a  certain  portion 
of  their  needs.  The  original  capitalizations  had  largely  been  con- 
verted into  terminal  structures  and  facilities,  and  into  roadbeds, 
against  which,  being  relatively  permanent  objects  for  expenditure, 
long  term  loans  had  been  contracted.  But  as  the  more  perishable 
rolling  stock  wore  out  and  its  replacement  became  necessary, 
either  from  funds  on  hand,  current  earnings,  or  the  proceeds  of  a 
new  loan,  the  two  former  expedients  appeared  undesirable  or  im- 
practicable to  these  companies,  and  yet  they  were  reluctant  to  in- 
crease their  regular  funded  indebtedness,  so  they  arranged  with  the 
car-builders  to  make  payment,  on  delivery  of  the  cars,  of  from  ten 
to  twenty-five  per  cent,  in  cash,  and  the  remainder  in  the  form  of 
noles.  usually  maturing  serially  over  a  period  of  years. 

900.  Tlie  scheme  was  quick  to  find  favor,  for  it  had  excellent 
bookkeeping  features:  it  kept  down  the  fixed  interest  charges  under 
the  old  methods  of  bookkeeping,  for  both  interest  and  principal 
could  be  met  out  of  income  account ;  it  distributed  the  maturities  so 
that  the  cars  could  pay  for  themselves;  and  discharged  the  debt 
during  the  life  of  the  cars,  that  there  might  be  no  paying,  as  it  were, 
for  dead  horses. 

901.  To  car-builders,  however,  as  to  city  contractors,  cash  is  more 
acceptable  than  a  quasi-floating  debt.  The  paper  of  the  railroad 
companies  was  often  disposed  of  for  what  it  would  bring  and  thus 
there  became  associated  with  equipment  bonds  the  distrust,  born 
of  ignorance,  which  still  clings  to  this  strongest  class  of  railroad 
security.  Originally  a  deferred  liability,  an  emergency  paper,  thrust 
upon  reluctant  creditors  who  had  a  narrow  market  to  liquidate 
upon,  in  time  every  possible  safeguard  was  placed  about  the  bonds, 
and  an  attractive  interest  rate  offered,  to  counteract  the  dis- 
advantages under  which  they  labored.    But  this  is  anticipating. 

292 


EQUIPMENT  TRUST  OBLIGATIONS  293 

The  Legal  History  of  Equipment  Trust  Obligations 

902.  Perhaps  the  first  step  toward  a  more  satisfactory  order  of 
things  was  accomplished  when  those  to  whom  the  railroad  was  in- 
debted for  its  equipment,  withheld  the  title  to  it  until  it  was  fully 
paid  for.  This  necessitated  the  creation  of  a  trust,  a  trust  agree- 
ment, and  a  trustee  in  whom  the  title  might  be  temporarily  vested. 
It  also  necessitated  the  drawing  of  a  contract  of  lease  under  which 
the  railroad,  in  turn,  might  be  protected  in  its  employment  of  the 
borrowed  property. 

903.  The  natural  thought  is  that  the  roads  could  have  bought  the 
cars  and  given  a  first  mortgage  on  them,  payable  in  such  amount 
annually,  or  semi-annually  that  the  serial  retirement  would  be 
more  rapid  than  the  depreciation,  and  thus  accumulate  a  constantly 
enlarging  equity  for  the  remaining  bonds. 

But  at  the  time  of  which  we  are  writing  the  railroads  already 
had  begun  to  realize  the  desirability,  especially  from  a  market  stand- 
point, of  refunding  and  consolidating  their  miscellaneous  mort- 
gage obligations  under  a  blanket  lien.  In  this  way  an  issue  of 
sufficient  size  might  be  created  to  obtain  general  recognition  and 
vogue  among  investors.  Confidence  was  more  easily  established 
and  the  basis  obtained  for  the  authorization  of  a  larger  amount  of 
bonds  if  the  lien  covered,  not  only  all  the  present  property,  but  that 
hereafter  acquired. 

Therefore  it  was  necessary  that  roads  with  blanket  mortgages  of 
this  sort  should  not  own  the  equipment  they  acquired  if  they  wished 
to  avail  themselves  of  the  advantages  of  serial  payment. 

904.  In  almost  all  states  rolling  stock  has  been  held  to  be  per- 
sonal property.  A  mortgage  on  personal  property  is  a  chattel 
mortgage;  and  in  1873,  when  the  modern  equipment  obligation  may 
be  said  to  have  been  invented,  it  was  necessary  to  record  chattel 
mortgages  wherever  the  property  was  held,  if  the  mortgagee  wished 
protection  against  all  other  claimants. 

905.  The  difficulties  and  expense  are  obvious  of  recording  mort- 
gages on  rolling  stock  that  is  likely  to  be  carried  anywhere  in  the 
country.  In  Connecticut,  for  instance,  prudence  would  have  re- 
quired that  the  mortgage  be  recorded  in  every  township.  But  in 
most  states  the  county  is  the  recording  unit.  If  the  rolling  stock 
were  carried  into  a  district  in  which  it  was  not  recorded  it  would 
be  liable  to  attachment  by  any  "  innocent  person  "  for  any  unad- 
justed debt  of  the  railroad,  and  this  attachment  would  have  priority 


284  EQUIPMENT  TRUST  OBLIGATIONS 

over  the  lien  securing  the  equipment  bonds.  To  be  sure,  the  "  inno- 
cent person"  in  such  a  situation  would  rarely  be  met,  but  the  bur- 
den of  the  proof  of  wrongful  intent  in  such  an  attachment  would 
be  upon  the  railroad.  If,  however,  a  trustee  holds  title,  the  equip- 
ment cannot  be  seized  for  the  railroad's  debts. 

906.  Since  the  chattel  mortgage  plan  was  undesirable,  one  might 
suppose  that  a  trustee,  manufacturer,  etc.,  might  in  the  early  days 
have  followed  the  more  recent  plan  of  conditional  sale,  i.e.  the  sale 
of  the  cars  to  the  road  might  have  been  made  contingent  upon  the 
prompt  payment  of  the  serial  instalments  which  represent  the 
accrued  interest  and  the  matured  portion  of  the  principal  of  the 
bonds. 

907.  But  this  plan,  in  turn,  was  usually  impractical,  for  few,  if 
any,  states  had  then  enacted  statutes  of  conditional  sale.  There 
was  general  and  well-grounded  prejudice  against  such  sales  of  any 
kind  of  merchandise,  as  enabling  debtors  to  withhold  recourse  to 
their  property  by  general  creditors. 

908.  Car  Trust  Certificates.  The  line  of  least  legal  resistance 
therefore  was  the  institution  of  the  car  trust  based  upon  the  lease 
principle,  the  lessor  being  the  manufacturer,  or  more  commonly,  a 
person,  company,  or  association  that  had  taken  over  the  equipment 
from  the  manufacturer.  Originally  the  contract  of  lease  was  supple- 
mented by  lease  warrants,  which  represented  in  the  guise  of  rental 
the  deferred  payments  and  interest.  The  lease  and  the  warrants,  in 
the  hands  of  a  trustee  or  of  the  lessor,  represented  the  immediate 
assets  against  which  Gar  Trust  Certificates  or  certificates  of  par- 
ticipation and  beneficial  interest  in  the  lease  were  issued.  But  the 
ultimate  assets  were  the  cars  themselves,  for  the  deed  of  trust 
authorized  the  sale  of  the  cars  to  satisfy  the  certificate  holders,  in 
case  the  lease  was  broken. 

909.  It  is  evident  that  the  investment  principles  underlying  the 
early  Car  Trust  Certificates  did  not  differ  in  essentials  from  mod- 
ern practice.  Legal  refinements,  to  be  sure,  were  introduced  subse- 
quently, but  they  are  matters  of  minor  interest.  The  lease  has  been 
found  sufficient  without  the  supplemental  warrants,  which  have 
been  discarded.  Of  recent  years  the  equipment  obligation  has  been 
reinforced  by  the  railroad's  guaranty  of  the  payments  representing 
principal  and  interest,  indorsed  on  each  certificate.  But  there  has 
yet  to  arise  an  instance  when  this  guaranty  has  saved  money  for 
security  holders. 

910.  The  minor  legal  devices  for  protecting  investors  under  the 


EQUIPMENT  TRUST  OBLIGATIONS  2»5 

Car  Trust  plan  are  so  various  that  misconceptions  sometimes  obtain. 
The  writer  has  in  mind  certain  persons  and  institutions  that  avail 
themselves  of  the  obvious  advantages  of  Equipment  Bonds  but  fear 
to  purchase  Car  Trust  Certificates.  This  is  particularly  true  when 
the  Certificates  are  the  "  stock  "  of  associations  formed  (as  in  the 
case  of  the  Pennsylvania,  the  Gould  roads,  and  the  Central  of 
Georgia)  simply  and  solely  to  purchase  equipment  and  lease  it  to 
railroads.  If  the  stock  were  only  bonds!  There  is  so  much  in  a 
name. 

911.  When  the  Car  Trust  Certificates  are  association  stock,  the 
stock  may  be  limited  to  the  amount  covering  the  lease  in  hand,  or 
it  may  be  unlimited  except  in  the  relation  of  the  amount  outstand- 
ing at  any  one  time  to  the  value  of  the  equipment;  but  the  certifi- 
cates will  always  be  in  series,  each  series  represented  by  its  own 
rolling  stock,  as  in  the  case  of  equipment  bonds. 

912.  In  its  purest  form,  however,  the  Car  Trust  Certificate  is 
not  stock  of  an  organization,  but  a  share  in, — a  certificate  of  benefi- 
cial interest  in, — a  fund  raised  to  purchase  the  equipment. 

913.  Car  Trust  Bonds.  Since  we  are  using  care  in  distinguishing 
types  of  equipment  obligations, — more  care  than  the  railroads  them- 
selves use, — we  reserve  the  term  Car  Trust  Bonds  for  the  direct 
obligations  of  corporations,  (let  us  say  car  manufacturers,  or  leasing 
associations),  as  distinguished  from  mere  certificates  of  interest  in 
the  leases.  The  collateral  security  for  these  bonds  is  a  mortgage 
on  the  lease  of  the  rolling  stock,  assigned  to  the  trustee.  But 
since  the  informing  principle  of  Car  Trust  Bonds  is  the  lease  rather 
than  the  conditional  sale,  they  are  of  the  category  we  have  already 
discussed,  rather  than  that  of  Equipment  Bonds,  to  which  we  shall 
come  presently.  It  is  necessary  that  all  leasing  persons,  associa- 
tions, and  corporations  shall  have  identity  distinct  from  that  of 
the  lessee  railroad   to  make  the  loan  valid. 

914.  The  "  Philadelphia  Plan."  Pennsylvania  is  about  the  only 
state  that  does  not  recognize  the  conditional  sale  as  a  proper 
principle  for  the  issuance  of  equipment  bonds.  Hence  the  Car 
Trust  plan  has  come  to  be  localized  in  this  state,  especially 
in  its  investment  center,  Philadelphia,  and  to  be  called  the  "  Phila- 
delphia Plan." 

915.  Pennsylvania  is  a  state  of  unusual  laws.    It  is  the  only  state 

in  which  prevails  the  statute  of  mortmain.     It  is  a  state  in  which    /^ 
a  conditional  sale  is  not  good  against  creditors  of  the  vendee.     A 
sale  of  personal  property,  with  change  of  possession  and  control, 


29f!  EQ  VI  I'M  EXT  TRUST  OBLIGATIONS 

passes  a  good  title  to  the  vendee,  and  any  agreement  of  which  the 
purpose  is  to  cover  up  the  sale  and  preserve  a  lien  in  the  vendor 
for  the  price  <>l"  the  goods  is  void  as  against  creditors  of  the  vendee: 

916.  The  principle  at  law  is  that  a  creditor  presumes  that  the 
possession  of  personal  property  implies  ownership,  and  he  is  likely 
to  extend  credit  on  the  presumption.  But  it  has  been  decided  that 
where  the  possession  of  personal  property  has  been  transferred  under 
an  express  contract  of  lease,  or  other  bailment  contract,  the  mere 
fact  that  there  is  superadded  an  executory  agreement  for  the  sale 
of  the  property  to  the  transferee  upon  the  payment  of  a  certain 
price,  at  any  time  during  bailment,  does  not  convert  the  bailment 
into  a  sale.  Therefore,  until  the  execution  of  the  contract  by  pay- 
ment of  the  price,  the  title  remains  in  the  bailor,  even  as  against 
the  bailee's  creditors. 

917.  This,  then,  is  the  method  used  in  Pennsylvania  to  circumvent 
the  law  against  conditional  sales.  The  principle  has  been  adjudi- 
cated there  time  after  time.  The  legality  of  the  lease  is  well  es- 
tablished. 

When  the  Car  Trust  Certificates  are  issued  by  a  Pennsylvania 
trustee,  association,  or  corporation,  and  the  railroad  agrees  to  pay 
such  issuer  money  sufficient  for  any  taxes,  assessments,  etc.,  which 
the  issuer  may  be  required  to  pay  or  deduct  from  interest  or  divi- 
dends on  the  certificates,  then  these  certificates  are  free  of  state  tax 
to  resident  owners.  By  this  device  any  railroad,  wherever  chartered 
or  operated,  can  make  its  car  trusts  free  from  state  tax  in  Penn- 
sylvania. 

The  agreement  to  pay  this  tax  is  not  such  a  hardship  to  the  rail- 
road company  as  might  appear,  for  although  it  is  the  duty  of  the 
trustee  or  the  railroad  company  to  pay  this  tax  when  the  owners 
are  known  to  be  residents  of  the  state,  yet  the  trustee  or  company 
is  not  obligated,  and  it  is  not  customary,  to  inquire  as  to  the  resi- 
dence of  the  holder  of  a  coupon  presented  for  payment. 

918.  Equipment  Bonds  or  Notes.  The  other  form  of  equipment 
obligation  is  called  Equipment  Bonds,  or  with  equal  propriety,  be- 
cause of  the  shortness  of  average  standard  duration  (5£  years), 
Equipment  Notes.  Car  Trust  Certificates  and  Car  Trust  Bonds  are 
not  synonymous  terms;  Equipment  Bonds  and  Equipment  Xotes 
are. 

919.  Whereas  Car  Trusts  are  issued  by  persons,  associations,  or 
trustees,  and  are  secured  by  deposit  of  the  contract  of  lease,  in 
trust,  and  are  guaranteed  usually  by  the  railroad,  Equipment  Bonds 


EQUIPMENT  TRUST  OBLIGATIONS  297 

are  usually  issued  by  the  railroad,  and  are  secured  by  a  lien  on 
the  contract  of  conditional  sale. 

920.  The  transition  from  a  certificate  of  beneficial  interest  in  a 
contract  of  lease  (the  Car  Trust)  to  a  direct  railroad  obligation 
secured  by  chattel  mortgage  on  rolling  stock  (the  Equipment  Bond), 
has  been  gradual.  The  disuse  of  lease  warrants,  the  supplemental 
railroad  guaranty,  the  substitution  of  a  formal  obligation  of  the 
lessor  for  the  certificate  of  interest  in  the  lease, — these  mark  the 
initial  stages  of  the  change. 

921.  The  incentive  for  this  change  is  the  fact  that  the  lease  is 
an  obvious  evasion  of  the  law.  In  most  states  the  courts  have 
regularly  held  that  where  the  plain  intent  and  purpose  is  a  con- 
ditional sale,  one  cannot  avoid  the  sale  by  calling  it  a  lease.  The 
practical  difficulties  of  making  conditional  sales  are  the  difficulties 
encountered  in  recording  chattel  mortgages.  To  avoid  multiplicity 
of  registration  most  states  have  passed  equipment  statutes,  like  rail- 
road mortgage  statutes,  permitting  a  single  act  of  registration  at 
the  state  capital,  rather  than  in  the  many  registration  districts.1 

922.  As  conditional  sales  of  equipment  have  been  facilitated  by 
legislation  the  indenture  of  lease  has  slowly  given  way  to  the  con- 
ditional sale,  although  the  inertia  and  timidity  of  the  legal  mind 
have  not  yet,  in  all  cases,  rid  the  trust  deed  of  the  lease  idea.  So  the 
parties  to  the  agreement  still  may  be  termed  the  Railroad  and  the 
Vendors,  but  the  equipment  may  be  designated  as  transferred  to  the 
trustee  for  lease  to  the  Railroad. 

The  Present  Legal  Status  of  Equipment  Obligations 

923.  Enough  has  been  said  to  indicate  that  the  present  legal 
status  of  Equipment  Bonds  is  complicated  and  peculiar.  The  trust 
deed,  covering  movable  property,  is  a  chattel  mortgage;  and  rep- 
resenting the  transfer  of  property  under  certain  provisos,  it  is  a 
bill  of  conditional  sale,  so  to  speak.  It  is  the  chattel  mortgage 
aspect  of  the  trust  deed  that  affords  the  material  security  to  the 
bonds,  just  as  in  any  mortgage  bonds;  it  is  the  conditional  sale 
aspect  that  prevents  title  from  going  into  the  hands  of  the  rail- 
road and  the  equipment  from  going  under  the  railroad's  blanket 

1  If,  at  this  writing,  there  are  any  states  that  do  not  simplify  by  statute 
the  recording  of  conditional  sales,  equipment  bonds  may  be  issued  there  under 
the  regular  chattel  mortgage  laws. 


298  EQUIPMENT  TRUST  OBLIGATIONS 

mortgage.  Although  title,  as  distinct  from  possession,  does  not  pass 
i.i  the  railroad  until  the  fulfilment  of  the  deferred  payments,  yet, 
to  all  intents  and  purposes,  the  equipment  does  belong  to  the  road 
and  is  the  tools  with  which  the  road  does  its  business. 

924.  In  this  connection  it  is  customary  to  compare  the  legal  sit- 
uation of  a  road's  mortgaged  rolling  stock,  in  foreclosure,  with  that 
of  a  mechanic's  tools,  which  are  exempt  from  seizure  in  bankruptcy 
proceedings.  Possibly  the  comparison  was  suggested  originally  by 
early  decisions  such  as  that  of  -Judge  Hallett,  in  the  United  States 
Circuit  Court,  in  the  case  of  the  Denver  and  Rio  Grande  in  1886, 
who  held  that  "  car  trusts,  principal  and  interest,  are  preferred 
securities  to  all  mortgage  claims  and  must  be  paid  out  of  the  reve- 
nue of  the  property  the  same  as  wages  and  labor."  It  is  extremely 
questionable  whether,  even  in  the  same  jurisdiction,  this  legal 
principle  would  be  upheld. 

The  analogy  is  somewhat  hasty.  The  mechanic  actually  owns  title 
to  his  tools,  and  their  exemption  from  execution  is  a  legal  excep- 
tion; but  the  railroad  does  not  have  title  to  the  equipment,  and  the 
result  that  the  equipment  cannot  be  levied  upon  for  the  company's 
debts  is  an  ordinary  legal  consequence  and  not  any  exemption  or 
exception  at  all. 

925.  Yet  the  analogy  is  ordinarily  valid  as  respects  the  under- 
lying principle  of  business  expediency.  Both  tools  and  rolling  stock 
are  personal  property  usually  necessary  to  the  conduct  of  business 
and  to  the  ultimate  satisfaction  of  creditors'  claims.  Courts,  both 
state  and  federal,  have  passed  upon  this  point  for  rolling  stock,  and 
in  receivership  have  usually  authorized  the  issuance  of  receiver's 
certificates,  or  otherwise  have  provided  for  the  prompt  payment  of 
interest  and  maturing  principal,  on  a  virtual  parity  with  the  pay- 
ment of  wages  and  the  purchase  of  necessary  materials  and 
supplies. 

926.  The  trend  of  recent  decisions  has  been  such  that  when,  as 
in  the  case  of  the  Detroit,  Toledo,  and  Ironton,  the  equipment  is  not 
essential  to  the  upkeep  of  the  road,  the  bondholders  must  look 
for  reimbursement  to  a  real  equity  in  the  mortgaged  property. 
They  even  may  have  to  face  decisions  such  as  that  given  about  two 
years  ago  by  a  Missouri  Court  to  the  effect  that 

"a  mortgage  of  the  property  acquired,  and  to  be  acquired,  and  of  the  income  of 
.  quasi-public  corporation,  such  as  a  railroad  company,  takes  a  lien  on  the  net  earn- 
ings after  the  current  expenses  of  operation  in  the  ordinary  course  of  business  are 
paid,  and  impliedly  agrees  that  the  gross  income  shall  be  first  applied  to  the  payment 
of  these  expenses. 


EQUIPMENT  TRUST  OBLIGATIONS  299 

"  The  test  of  the  quality  which  entitles  a  claim  to  a  preference  over  the  mortgage  in 
foreclosure  is  whether  the  consideration  of  the  claim  was,  or  was  not,  a  part  of  the 
current  expenses  of  the  ordinary  operation  of  the  corporation. 

'  •  Neither  the  fact  that  the  consideration  of  the  claim  conserved  the  property  and 
increased  the  security  of  the  mortgage,  nor  the  fact  that  it  was  necessary  to  keep  the 
mortgagor  a  going  concern  or  to  continue  its  business  or  operations,  will  raise  a  prefer- 
ential equity  in  its  favor,1  if  its  consideration  was  not  a  part  of  the  ordinary  opera- 
tions of  the  mortgagor. 

"  Claims  for  the  purchase  price  or  the  rental  of  engines,  freight  and  passenger  cwa 
are  not  entitled  to  preference  in  payment  out  of  the  income  or  out  of  the  corpus  of  the 
mortgaged  property  over  tlwse  of  creditors  secured  by  prior  mortgages."  2 

927.  It  will  be  understood  that  under  such  a  ruling  a  court  might 
hinder  a  receiver  in  the  performance  of  his  plain  duty  as  business 
manager  of  the  railroad  by  withholding  permission  for  the  issuance 
of  certificates.  But  it  is  not  probable  that  any  body  of  legal  de- 
cisions will  overlook  the  fact  that  equipment  trust  obligations  may 
have  a  preferential  claim  from  a  business,  though  not  from  a  legal 
point  of  view. 

928.  The  Modern  Trust  Deed.  In  describing  the  development  and 
present  forms  of  equipment  obligations  we  have  touched  upon  the 
more  important  aspects,  especially  legal,  of  the  modern  equipment 
trust  deed,  but  these  further  features  are  of  moment.  It  is  usually 
a  three-party  agreement  subscribed  to  by  the  railroad,  the  bond 
house  (or  other  company)  as  vendor,  and  the  trust  company  as 
trustee  for  the  bondholders.  It  provides  for  the  conspicuous  mark- 
ing of  each  piece  of  rolling  stock  with  the  serial  number  under 
which    it    was    built,    and   even   for   metal   plates   inscribed    with 

" and  Co."  (the  vendors),  the  plates  and  numbers  not  to 

be  changed  without  consent  of  the  trustee.  "  The  railroad  will  not 
allow  the  name  of  any  person,  association,  or  corporation  to  be. 
placed  on  any  of  the  said  equipment  as  a  designation  which  might 
be  interpreted  as  a  claim  of  ownership  by  the  railroad  " ;  provided 
that  the  railroad  may  letter  its  engines,  tenders,  and  cars  with  its 
own  name  for  proper  identification. 

929.  The  railroad  shall  keep  the  equipment  in  proper  and  com- 
plete repair  and  renew  and  replace  such  as  may  be  worn  out,  lost, 
or  destroyed,  with  other  of  substantially  the  same  quality  and 
character.  The  railroad  shall  furnish  a  complete  statement  con- 
cerning the  equipment  and  its  whereabouts,  at  least  once  a  year, 
and  allow  the  vendors  access  to  the  premises  and  facilities  for  the 

1  The  italics  are  ours.  2The  italics  are  ours. 


300  KQI  IPMIONT  TRUST  OBLIGATIONS 

inspection  of  the  property  to  which  il  holds  title.  The  railroad 
shall  insure  the  property  in  I  rust  for  the  holders  of  bonds  against 
loss  or  damage  by  fire  and  other  loss  that  is  a  usual,  insurable  risk, 
hi  an  amount  equal  to  (say)  twenty  per  cent,  of  its  value  and  in 
companies  approved  by  the  vendors;  (twenty  per  cent,  being  amply 
sufficient  to  cover  all  possible  risk  to  such  scattered  property  as 
rolling  stock).  The  railroad  agrees  to  pay  all  taxes,  assessments, 
or  charges  against  the  equipment,  and  agrees  not  to  permit  it  to  be 
pledged  for  taxes  or  other  obligations  of  the  railroad. 

The  Financial  History  of  Equipment  Trust  Obligations 

930.  It  will  be  observed  from  the  abstract  that  the  trust  agree- 
ment is  very  exacting  in  its  requirements  for  the  protection  of 
bondholders.  Indeed,  the  development  in  this  document  of  legal 
and  financial  principles  of  safety  has  been  remarkable.  How  well 
the  trust  deed  has  served  its  purpose,  even  in  days  when  not  so  care- 
fully drawn  as  at  present,  is  evidenced  by  the  history  of  equipment 
trust  obligations  when  put  to  the  test  of  railroad  receiverships  and 
reorganizations.  The  Interstate  Commerce  Commission  has  issued 
no  studies  or  history  of  car  trusts  or  equipment  bonds  of  railroads 
in  receivership.  Therefore  the  writer  has  examined  most,  if  not 
all,  the  reorganization  plans  of  companies  having  such  securities 
outstanding  during  the  past  twenty-five  years  or  so,  with  results  of 
which  the  following  notes  are  a  summary: 

931.  Since  1885  there  has  been  an  average  of  considerably  more 
than  one  company  a  year,  with  equipment  securities  outstanding, 
that  has  been  in  such  straits  as  to  default  on  its  direct  obli- 
gations. 

932.  In  188G  the  Denver  and  Rio  Grande  Railroad,  reorganized 
after  foreclosure,  owed  $3,476,000  in  6  per  cent,  and  7  per  cent, 
equipments.  It  was  in  adjudication  of  these  bonds  that  Judge 
Hallett  rendered  the  favorable,  but  untenable,  decision  quoted 
previously.  Under  an  agreement  with  the  car  trust  holders,  $600,- 
000  of  the  bonds  were  paid  in  full  and  the  remainder  exchanged 
for  consolidated  mortgage  bonds  and  preferred  stock  that  later 
were  worth  about  forty  per  cent,  more  than  the  car  trusts.  During 
receivership  no  other  issues  received  interest.  This  is  one  of  the 
very  few  instances  in  which  cash  in  full  was  not  paid  in  receivership 
on  maturing  principal  and  interest  of  equipments,  and  in  all  cases 
of  exception  to  the  general  rule  it  is  to  be  remembered  that  the 


EQUIPMENT  TRUST  OBLIGATIONS  301 

consent  of  a  majority  of  the  bondholders  was,  of  necessity,  first 
obtained. 

933.  In  1888  the  Chesapeake  and  Ohio  was  reorganized  without 
foreclosure,  and  the  equipment  bonds,  amounting  to  $1,371,000,  were 
undisturbed  though  all  other  securities  were  reduced  in  rate  or  re- 
funded for  a  less  amount. 

934.  In  1892  the  Central  Railroad  and  Banking  Company  of 
Georgia,  then  leased  to  the  Georgia  Pacific,  went  into  the  hands  of 
a  receiver;  in  1894,  the  Georgia  Pacific,  which,  in  turn  was  leased 
to  the  Richmond  and  Danville,  followed  suit,  drawing  down  with  it 
the  Richmond  and  Danville  in  foreclosure  of  the  latter's  consolidated 
mortgage.  The  interest  and  maturing  principal  of  the  equipments 
of  all  three  roads,  amounting  to  several  millions,  were  paid  in  full. 
In  several  cases  the  mortgage  and  debenture  bonds  were  unfavorably 
modified  or  temporarily  reduced  in  amount  under  the  Richmond 
Terminal  Company's  reorganization  plan.  A  division  of  the  Rich- 
mond Terminal  System  had  outstanding  Improvement  and  Equip- 
ment 5s  which  were  exchanged  for  4  per  cent,  bonds  and  preferred 
stock,  ultimately  worth  considerably  more  than  the  replaced  bonds, 
but  the  5s  were  not  strictly  an  equipment  issue  and  should  not 
be  considered. 

935.  In  1892  the  Savannah,  Americus,  and  Montgomery,  now  a 
part  of  the  Seaboard  Air  Line,  suffered  receivership.  The  equip- 
ment bonds  were  untouched. 

936.  In  1893  the  Toledo,  St.  Louis,  and  Kansas  City  Railroad, 
now  the  Toledo,  St.  Louis,  and  Western,  went  into  receivership.  It 
defaulted  upon  its  $9,800,000  mortgage  bonds.  The  equipment  pay- 
ments were  met,  as  usual,  by  the  receivers. 

937.  In  1895  the  Atchison,  Topeka,  and  Santa  Fe  was  reorgan- 
ized after  foreclosure.  During  receivership,  the  court  authorized 
payment  of  interest  and  maturing  principal  on  over  $2,000,000  of 
equipment  bonds  and  car  trust  obligations.  Interest  was  defaulted 
on  the  mortgage  bonds.  At  reorganization  $1,200  in  new  general 
mortgage  bonds  was  reserved  to  retire  each  $1,000  equipment  bond 
at  maturity.  Practically  all  other  securities  were  reduced  in  rate 
or  refunded  at  a  less  amount.  Of  equipment  bonds  the  reorganiza- 
tion plan  says :  "  These  constitute  charges  upon  the  revenues  of  the 
company  prior  to  the  General  Mortgage  bonds,  the  interest  and 
instalments  on  the  same"  (equipments)  "  having  been  paid  under 
the  order  of  the  court  by  the  receivers." 

938.  In  the  same  year  the  New  York,   Lake  Erie,   and  West- 


302  EQUIPMENT  TRUST  OBLIGATIONS 

era,  now  the  Erie,  was  reorganized  after  foreclosure.  During  re- 
ceivership, receiver's  certificates  were  issued  to  pay  maturing  prin- 
cipal and  interest  on  the  $2,000,000  of  outstanding  equipments,  and 
after  foreclosure  securities  were  sold  for  the  same  purpose.  First 
mortgage  bonds  were  left  intact,  but  other  securities  were  reduced 
in  rate  or  amount. 

939.  In  180.*),  also,  ihe  Union  Pacific  was  reorganized  after  fore 
closure.     The  equipment  bonds,  of  which  $1,149,000  were  outstand- 
ing, were  undisturbed  and  new  general  mortgage  bonds  were  re- 
served to  pay  them  at  maturity.    All  other  securities  including  the 
first  mortgage  bonds  were  reduced  in  rate  or  amount. 

940.  The  following  year  the  Baltimore  and  Ohio  passed  into  the 
hands  of  receivers,  and  was  reorganized  without  foreclosure  in  1898. 
$300,000  in  equipment  obligations,  maturing  within  these  three  years, 
were  extended  with  the  consent  of  the  holders  till  1899,  at  increased 
interest.  And  during  the  same  period  the  United  States  Circuit 
Court  authorized  an  issue  of  $3,400,000  car  trust  certificates  and 
$5,000,000  receiver's  certificates,  part  of  which  latter  were  "  to  pay 
for  the  restoration  of  the  rolling  stock  and  equipment  of  the  rail- 
road company."  In  all  about  $11,000,000  was  applied,  directly  or 
indirectly,  by  the  issuance  of  receiver's  certificates,  to  the  upkeep 
and  improvement  of  the  company's  equipment.  The  charges  incurred 
by  these  certificates  were  paid  in  full  though  almost  all  other  se- 
curities were  reduced  in  rate,  and  interest  and  rental  obligations 
suffered  temporary  default. 

941.  In  this  same  year,  1896,  the  Norfolk  and  Western  was  re- 
organized after  foreclosure.  Of  the  $7,239,000  equipments,  $3,125,- 
000  were  paid  and  $4,114,000  were  refunded  at  par  in  bonds  with  a 
bonus  of  preferred  stock.  The  refunding  bonds  and  preferred  later 
became  worth  140  cents  on  the  dollar.  Several  issues  of  mortgage 
bonds  were  reduced  in  rate  or  amount.  This  was  another  instance 
in  which  cash  was  not  paid  on  all  maturing  equipments. 

942.  In  189G  the  Philadelphia  and  Reading  was  reorganized  after 
foreclosure.  The  $7,300,000  of  equipments  were  paid,  partly  by 
assessment.    Junior  securities  were  refunded  for  a  less  amount. 

943.  Regular  and  full  payments  were  made  on  $3,000,000  equip- 
ment bonds  of  the  Northern  Pacific,  reorganized  after  foreclosure  in 
1896.    In  this  case  all  other  securities  suffered  in  rate  or  amount. 

944.  The  next  foreclosure  (1S99)  on  a  road  with  equipment 
obligations  was  that  of  the  Columbus,  Hocking  Valley,  and  Toledo 
Railway,   now  the   Hocking  Valley  Railroad.     All   mortgages   de- 


EQUIPMENT  TRUST  OBLIGATIONS  303 

faulted.  Interest  on  the  $1,000,000  equipments  was  paid,  and  ten 
per  cent,  of  the  principal  was  retired  regularly  according  to  the 
provisions  of  the  equipment  sinking  fund. 

945.  In  1900  the  Kansas  City,  Pittsburg,  and  Gulf  was  succeeded 
in  foreclosure  by  the  Kansas  City  Southern.  All  the  old  securities 
except  the  equipments  were  reduced  in  rate  and  amount  when 
exchanged  for  new  first  mortgage  bonds  on  the  latter  company, 
but  sufficient  of  the  new  bonds  were  sold  to  pay  off  the  equipment 
charges  when  due  ($1,900,000). 

946.  On  August  1,  1905,  a  receiver  was  appointed  for  the  Pitts- 
burg, Shawmut,  and  Northern  Railroad.  Both  mortgage  issues, 
the  $164,000  First  5s  and  the  $14,491,600  Refunding  Mortgage  4s, 
made  their  last  coupon  payments  in  the  previous  February.  The 
equipment  bonds  were  promptly  paid  as  usual,  although  the  road's 
misfortune  caused  an  immediate  decline  in  market  value  from  a  4f 
to  a  5^  per  cent,  investment  basis.  Moreover,  in  1907,  the  receiver 
issued  $592,000  more  on  a  6£  and  7  per  cent  basis.  The  high 
rate  was  due  to  the  very  poor  credit  of  the  road.  In  Octo- 
ber, 1910,  $220,000  receiver's  equipment  trust  certificates  were 
authorized. 

947.  On  December  4th  of  the  same  year  (1905),  the  Cincinnati, 
Hamilton,  and  Dayton,  and  its  subsidiary,  the  Pere  Marquette, 
went  into  receivership.  The  interest  on  the  underlying  mortgage 
bonds  of  the  Cincinnati,  Hamilton,  and  Dayton,  and  the  interest 
and  maturing  instalments  of  the  $2,640,000  equipments,  was  un- 
affected, but  at  the  time  of  reorganization  in  1909  the  road  was 
$1,046,000  in  arrears  of  interest  on  its  junior  mortgage  bonds,  not 
including  the  interest  on  the  $15,000,000  Consolidated  Mortgage 
bonds  held  as  collateral.  Ultimately  defaulted  interest  was  made 
up  and  onlv  the  note  holders  suffered  materially.  For  each  note 
they  were  given  $60  in  cash  and  $1,000  New  General  Mortgage  (De- 
ferred Income)  Bonds. 

The  Pere  Marquette,  like  its  lessee,  readjusted  its  finances  in 
1907  without  foreclosure  of  the  property.  Some  of  its  mortgage 
bonds  were  in  default  for  about  two  years,  but  the  payments  on 
its  $4,700,000  equipments  were  maintained. 

The  court  authorized  the  receiver  of  the  Pere  Marquette  to  issue 
$1,730,000  equipment  obligations  to  purchase  new  equipment,  and 
also  some  short  time  equipment  6  per  cent,  notes  to  take  up  the 
$2,600,000  5  per  cent,  notes,  maturing  March  2,  190S.  Some  of 
these  refunding  equipment  notes  were  offered  at  par  and  interest. 


304  EQUIPMENT  TRUST  OBLIGATIONS 

What  other  sort  of  s1h.iI  time  bond  upon  a  road  in  such  a  condi- 
tion as  the  Pere  Marquette  could  sell  upon  a  <>  j»er  cent,  basis? 

948.  In  January,  L908,  the  Seaboard  Air  Line  went  into  receiver- 
ship. On  January  1st,  in  anticipation  of  default,  two  New  York 
banking  houses  offered  to  purchase  at  full  value  maturing  interest 
on  all  underlying  bonds  and  car  trusts,  and  maturing  principal 
of  the  latter.  Receiver's  certificates  were  issued  to  reimburse  the 
bankers. 

Until  the  company  r<  ed  possession,  without  foreclosure,  in 
November,  1909,  the  Firsl  Mortgage  4s  and  the  General  Mortgage 
5s  were  in  default  of*  their  interest.  The  plan  of  readjustment 
caused  the  majority  of  the  First  4s  to  be  stamped  callable.  Other- 
wise they  were  not  disturbed,  but  the  General  5s  were  exchanged 
at  parity  for  5  per  cent.  Interest  Adjustment  (cumulative  income) 
bonds.  The  immunity  of  equipments  had  become  so  much  a  matter 
of  course  that  the  $6,000,000,  approximately,  of  these  bonds  were 
barely  mentioned  in  the  plan  of  readjustment. 

949.  Immediately  following  the  Seaboard  Air  Line  (February 
5th,  1908),  the  Detroit,  Toledo,  and  Ironton  was  turned  over  to  a 
receiver.  The  subsequent  history  of  this  road  is  of  more  interest 
to  us  than  the  history  of  any  other,  for  it  furnishes  the  only  case 
of  a  serious,  permanent  equipment  trust  default.  The  Detroit, 
Toledo,  and  Ironton  is  one  of  the  poorest  railroad  properties  of  any 
size  in  the  country.  In  only  one  of  its  nine  years  of  existence  has 
it  earned  its  interest  charges.  Furthermore,  unwise  management 
had  brought  the  road  to  such  a  pass  that  when  it  became  insolvent, 
and  defaulted  on  all  its  other  notes  and  bonds,  there  was  not,  for  a 
time,  sufficient  business  to  necessitate  the  retention  of  all  the 
equipment,  nor  had  the  company  sufficient  credit  to  raise  the  neces- 
sary funds  as  rapidly  as  the  manufacturers  of  this  equipment  (who 
held  a  large  part  of  the  bonds)  desired.  Therefore,  about  a  year 
later,  in  April,  1909,  the  equipment  covered  by  the  $1,656,000  Equip- 
ment Trust  4^s  of  1905  was  surrendered  to  the  Trust  Company 
of  America  as  trustees  for  the  American  Car  and  Foundry  Company 
et  al.  The  equipment  was  sold  at  auction  the  following  month  to 
the  St.  Louis-Union  Trust  Company,  in  behalf  of,  and  acting  for 
the  holders  of  the  entire  outstanding  issue.  The  price  of  $1,200,000 
was  paid  simply  by  the  cancellation  of  the  debt  to  that  extent. 

The  American  Car  and  Foundry  Company  will  probably  apply 
to  the  courts  for  a  deficiency  judgment,  but  it  is  exceedingly  doubt- 
ful if  the  noteholders  are  ever  fully  reimbursed. 


EQUIPMENT  TRUST  OBLIGATIONS  305 

A  reading  of  the  deed  of  trust  leaves  no  question  about  the  regu- 
larity of  the  issue  as  an  equipment  obligation  of  the  conditional 
sale  type. 

We  have  emphasized  the  fact  that  so  far  as  concerns  collateral 
security,  equipment  bonds  become  stronger  as  they  grow  older. 
The  $1,656,000  4^s  of  1905  were  part  of  an  issue  of  $2,070,000  due 
$207,000  annually.  Two  instalments  only,  therefore,  had  been 
paid.    The  theoretical  equity  was  not  great. 

The  Detroit,  Toledo,  and  Ironton,  however,  was  also  responsible 
in  1909  for  the  remaining  $200,000  of  an  issue  of  $400,000  Detroit 
Southern  car  trusts,  $40,000  of  which  were  due  annually.  The 
equity  in  this  property  was  greater  and  hence  all  payments  have 
been  made  on  the  Detroit  Southern  bonds,  although  there  was  about 
a  two-months1  delay  in  interest  when  the  road  first  became  insolvent. 

950.  On  February  13,  1908,  the  Chicago,  Cincinnati,  and  Louis- 
ville was  turned  over  to  a  receiver  after  default  on  all  its  mort- 
gage bonds.  There  was  a  floating  debt  of  $1,750,000  and  many  small 
claims  were  overdue.  The  road  was  short  of  equipment  and  on 
May  26  the  receiver  was  authorized  to  issue  $1,000,000  3-year  6 
per  cent,  certificates,  part  of  which  were  used  in  the  purchase 
of  new  cars  and  $100,000  for  the  rental  of  the  equipment  held  under 
car  trust  agreements  as  payments  matured  during  the  succeeding 
six  months. 

No  further  provision  of  moment  seems  to  have  been  made  for 
the  equipments  during  the  receivership,  for  when  the  road  was 
acquired  at  foreclosure  by  the  Chesapeake  and  Ohio  of  Indiana, 
the  purchase  was  made  subject  to  the  following  unpaid  equipment 
liens : 

Hoosier   Equipment   Company   First   Mortgage   5s    (with 

interest  from  January  1,  1909) $200,000 

Car  Trusts,  American  Loan  and  Trust  Company  5s  (with 

interest  from  December  1,  1908) 150,000 

Burnham   Williams    Equipment   Agreement    (with   5   per 

cent,  interest  on  $50,656  thereof  from  March  2,  1908) 91,194 

Haskell  and  Barker  Car  Company  Equipment  Agreement 

(with  4  per  cent,  from  May  17,  1909) 177,744 

951.  Railroad  receiverships,  after  the  panic  of  1907,  were  nu- 
merous. In  the  same  month  that  the  Detroit,  Toledo,  and  Ironton 
and  the  Chicago,  Cincinnati,  and  Louisville  went  under, — on  the 


306  EQUIPMENT  TRUST  OBLIGATIONS 

26th, — the  International  and  Great  Northern  followed,  having 
for  some  time  been  in  arrears  of  interest  on  its  Third  Mort- 
gage 4s.  At  the  next  interest  period  the  Second  Mortgage  5s  omitted 
payment,  and  neither  issue  has  yielded  anything  since.  At  the 
time  of  bankruptcy,  the  road  had  about  $500,000  of  equipments 
outstanding.    Care  has  been  taken  of  these  regularly. 

952.  When  the  Wheeling  and  Lake  Erie  became  bankrupt  in 
June,  1908,  interest  was  defaulted  on  the  $8,000,000  5  per  cent,  notes, 
secured  by  $12,000,000  General  Mortgage  4s.  No  interest  had  ever 
been  paid  on  this  collateral,  which  at  no  time  had  ever  been  in  the 
hands  of  the  public.  The  5  per  cent,  notes  matured  August  1,  1908. 
but  still  remain  unpaid. 

For  a  month  or  two  there  was  default  on  the  Equipment  5s  of 
1922,  but  only  until  the  receiver  obtained  permission  from  the 
United  States  Circuit  Court  to  pay  the  July  coupons.  It  is  re- 
ported that  since  then  the  price  of  the  equipments  has  held  well. 

953.  But  the  Wheeling  and  Lake  Erie  equipments  well  illustrate 
the  danger  of  departure  from  the  ten-year  serial  form  on  which  we 
lay  so  much  emphasis.  The  original  amount  of  the  issue  was 
$2,500,000,  and  the  cost  was,  as  usual,  10  per  cent,  in  excess,  or 
$2,750,000.  The  bonds  are  a  direct  obligation  of  the  road,  but  they 
run  for  20  years,  with  the  annual  sinking  fund  only  3  per  cent,  for 
the  first  four  years,  and  4,  5,  6,  and  7  per  cent,  for  the  succeeding 
periods  of  4  years  each. 

954.  At  the  time  of  the  temporary  default  only  $502,000  (20.1 
per  cent.)  had  been  amortized,  although  $525,000  (25  per  cent.) 
should  have  been  paid  according  to  the  terms  of  the  trust  deed. 
This  is  another  illustration  of  the  inefficacy  of  sinking  funds.  If, 
however,  the  issue  had  been  of  standard  form,  $1,625,000  (65  per 
cent.)   would  have  been  amortized. 

The  theoretical  depreciation  of  the  rolling  stock,  based  on  a 
15-year  life,  was  about  $1,200,000  (or  43  1-3  per  cent,  of  the 
$2,750,000  cost),  leaving  a  value  of  $1,550,000,  against  which  the 
outstanding  debt  was  $1,998,000  or  $44S,000  more  than  the  prop- 
erty was  worth. 

But  by  the  lO-j^ear  serial  method,  with  semi-annual  payment,  only 
$875,000  of  bonds  would  have  been  outstanding  and  the  value  of  the 
property  would  have  been  $675,000  (or  77  per  cent.)  more  than 
the  debt. 

955.  When  the  Norfolk  and  Southern  was  turned  over  to  receivers 
on  July  1,  1908,  there  were  outstanding  $2,203,047  three-year  col- 


EQUIPMENT  TRUST  OBLIGATIONS  307 

lateral  trust  notes  dated  November  1,  1907,  that  had  as  part  col- 
lateral 11,200,000  Norfolk  and  Southern  "  straight "  10-year  5  per 
cent,  equipment  bonds,  the  principal  of  which  was  to  be  paid  the 
trustee  when  due.  As  collateral,  none  of  these  equipments  were  in 
the  hands  of  the  public,  and  no  interest  was  paid  on  them.  The 
collateral  notes  themselves  were  not  affected,  although  there  was 
default  of  interest  on  the  |15,000,000  First  and  Refunding  5s.  In 
the  road's  reorganization,  May  5,  1910,  as  the  Norfolk  Southern,  the 
equipments  were  canceled  with  the  retirements  of  the  notes. 

956.  Still  two  other  roads  with  equipment  debt  went  wrong  in  1908. 
On  August  19th,  when  the  Chicago  Southern  was  turned  over,  a  ma- 
jority of  the  178,121.78  equipment  notes  were  in  default.  These 
notes  were  not  of  the  formal  equipment  type,  nor  in  the  hands  of 
investors.  The  rolling  stock  pledged  was  235  side-dump  cars  for 
company  service,  which,  with  10  locomotives,  was  all  the  rolling 
stock  the  company  owned.  On  March  10,  1909,  the  vendor  of  the  cars 
claimed  the  right  to  retake  and  sell  them,  and  also  claimed  there 
was  due  from  the  receiver,  for  rental  and  destroyed  cars,  the  further 
sum  of  $15,000.  The  vendor,  moreover,  claimed  that  a  sale  of  the 
cars  would  fail  to  pay  the  amount  due  on  the  notes  by  $33,000, 
and  therefore  that  this  amount  would  be  a  further  claim  on  the 
receivership  estate.  Against  this  claim  the  receiver  had  a  counter 
claim  for  repairs  and  transportation  amounting  to  about  $6,800. 
Believing  that  the  dump  cars  were  practically  useless  for  the  pur- 
poses of  the  road,  the  receiver  made  a  complete  settlement  of  the 
respective  claims,  under  which  the  notes  were  discharged,  the  cars 
were  returned  to  the  vendor,  (as  in  the  case  of  the  Detroit,  Toledo, 
and  Ironton),  and  a  cash  payment  of  $5,000  made  by  the  receiver. 

957.  The  subsidiary  Southern  Indiana,  which  went  into  receiver- 
ship at  the  same  time  as  the  parent  company,  had  defaulted  the 
first  of  the  month,  on  its  First  Mortgage  4s.  On  November  1st 
the  General  Mortgage  bonds  suffered  the  same  way. 

At  that  time  there  were  in  the  hands  of  the  public  $753,333.95  of 
equipment  notes,  including  interest  due.  In  settlement,  the  note- 
holders accepted  $200,000  cash,  raised  by  receiver's  certificates, 
and  $553,333.95  payable  one-fourth  on  November  1,  1909,  and  one- 
eighth  each  May  and  November  until  the  final  settlement,  November 
1,  1912. 

The  Chicago,  Terre  Haute,  and  Southwestern  took  over  both  the 
above  properties  on  January  1,  1911,  without  disturbing  the  prin- 
cipal of  the  Southern  Indiana  First  4s,  but  holders  of  the  other 


308  EQUIPMENT  TRUST  OBLIGATIONS 

securities  were  given  the  usual  cumulative  income  bonds,  and  some 
stock. 

958.  The  record  of  the  equipment  bonds  of  the  Atlanta,  Birming- 
ham, and  Atlantic  is  next  in  order.  The  road  went  into  receivership 
on  January  2,  1909,  as  the  result  of  default  the  day  before  on  the 
First  5s  of  193G.  This  default  has  continued.  The  company's  col- 
lateral trust  notes  have  fared  better;  they  were  due  in  1910  and  have 
been  extended  two  years  to  be  sure,  but  the  coupons  have  been  met 
with  slight  delay  and  the  plan  of  reorganization  contemplates  their 
payment. 

.Most  of  the  road's  equipment  and  cars  were  held  under  the  equip- 
ment trusts,  which  amounted  to  over  $2,600,000.  The  January,  1909, 
interest  and  the  maturing  instalment  of  the  Series  B  equipments 
was  not  paid  until  February  10th,  but  there  has  been  no  trouble 
since.  The  coupon  and  instalment  payment  of  Series  A  bonds  was 
due  in  May,  but  was  delayed  for  about  two  months. 

The  relative  security  of  the  road's  "First"  Fives  (largely  a  sec- 
ond mortgage  issue)  and  of  the  equipments  is  evidenced  by  the 
market.  The  Series  A  Equipment  5s  of  the  1917  maturity  were 
offered  in  December,  1909,  at  99^  and  interest,  and  at  the  same 
time  the  First  Fives  of  1936  were  offered  at  50  flat. 

959.  On  May  1,  1910,  the  Buffalo  and  Susquehanna  Railway  de- 
faulted on  its  $6,000,000  First  Mortgage  4£s  and  went  into  receiver- 
ship. The  road  had  for  three  years  been  operating  the  Buffalo  and 
Susquehanna  Railroad,  and  guaranteeing  4  per  cent,  dividends  on 
both  classes  of  the  Railroad's  stock  and  paying  the  bond  interest, 
etc.  On  July  23  the  Railroad  also  went  into  receivership.  It  still 
pays  interest  on  the  small  First  Mortgage  issue  of  $61,000  out- 
standing, but  the  $9,510,000  First  Refunding  4s  are  in  default. 
The  Railroad  has  no  equipment  bonds,  but  the  Railway  has  four 
series  of  equipments  amounting  now  to  $1,606,000.  Interest  and 
maturing  principal  have  not  suffered  a  day's  delay  in  payment. 

960.  Depreciation  and  Serial  Payment.  The  fact  that  the  prior 
payment  of  equipment  bonds  is  not  an  inherent  legal  right,  but  a 
matter  of  business  expediency  very  generally  recognized  by  the 
courts,  probes  whatever  weakness  there  is  in  equipment  bonds.  If, 
because  of  its  special  nature  (as  in  the  case  of  the  Chicago  South- 
ern), or  because  there  is  too  much  of  it  (as  in  the  case  of  the  Detroit, 
Toledo,  and  Ironton),  the  receiver  rejects  the  equipment  and  per- 
mits the  mortgage  to  be  foreclosed,  then  it  becomes  very  pertinent 
to  inquire  whether  the  rolling  stock  will  sell  at  auction  for  the  full 


EQUIPMENT  TRUST  OBLIGATIONS 


309 


value  of  the  bonds.     Let  us  consider,  then,  what  material  or  auction 
values  lie  behind  the  bonds. 

961.  In  the  first  place  there  is  from  ten  to  twenty-five  per  cent, 
equity  in  the  property  when  the  bonds  are  issued, — that  proportion 
of  the  cost,  as  we  have  stated,  being  paid  in  cash.  Since  the  prin- 
cipal usually  matures  in  equal  semi-annual  instalments  over  a  pe- 
riod of  (usually)  ten  years,  the  outstanding  amount  of  the  mort- 
gage decreases  five  per  cent,  every  six  months.  Rolling  stock, 
particularly  engines  and  passenger  coaches,  depreciates  rapidly,  but 
not  so  rapidly  as  the  mortgage  decreases,  and  has  an  average  life 
for  selling  purposes  of  from  fifteen  to  twenty-five  years.  With  the 
development  of  steel-frame  construction  and  the  general  improve- 
ment in  car-building  the  tendency  is  toward  longevity.  Reckoning 
upon  fifteen  years  and  an  arbitrary  uniform  decrease  in  selling 
value,  and  assuming  a  10  per  cent,  equity  when  the  bonds  were 
issued,  we  can  readily  figure  what  theoretical  auction  security  is 
behind  the  bonds  at  any  time  during  their  life.  The  accompanying 
diagram  may  assist. 


962. 


Chart  I 


D 

agram 

sJwiving  i 

lu 

j  growth  oi 

equipment 

f  equity 
bond 

in 

a 

ten 

year 

•  seria< 

I 

i 

?i 

ri 

B, 

Al 

E 

\n 

U  III         IV 


VI         VII       VIII        IX  X  XI         XII       XIII      XIV       XV 


Perpendicular  distance  represents  value. 
AB=Amount  of  mortgage  at  issuance. 
AC=Value  of  rolling  stock  at  issuance. 
BC=Equity  in  rolling  stock  at  issuance. 
BE=Line  of  diminishing  mortgage  debt. 
CD = Hypothetical  line    of  diminishing 
value. 


Horizontal  distance  represents  time. 
I,  II,  III,  etc.  =Number  of  years  since 

issuance. 
1,     2,    3,    etc. = Serial   Instalments    of 

mortgage. 
r=ratio  of  equity  to  value,  i.e.   margin 

of  safety. 


310  EQUIPMENT  TRUST  OBLIGATIONS 

Problem  (the  simplest  case  and  the  simplest  solution.) 

Find  the  margin  of  safety  for  ihe  bonds  at  the  end  of  five  years. 


Let      AiBi  =  Amount  of  mortgage  outstanding  at  end  of  5  yrs. 

AiCi= Value  of  rolling  stock  at  end  of  5  yrs. 

BiC,  =  Equity  of  rolling  stock  at  end  of  5  yrs. 

ri=Margin  of  safety  at  end  of  5  yrs. 

Then  A,B,=-£  AB  (50£  of  mortgage  having  matured) 

And    AiCi  =  f  AC  (value  having  depreciated  |  in  5  yrs.) 

BC      1 
Now        r  =  •—=:— =\Q%  at  issuance 

B.C, 


1     Aid 
But    B,C,  =  A,Ci  — A,B,     (See  Diagram) 

And  ^  =l-vJ  (Dividing  by  A^,) 


A.Ci  A.Ci 

AX 

AC 


=  1_+  AB  (Substituting) 


4VACV 
_      3    _9  /AB 

""      4*  10  VAC 


=-  by  Diagram  j 


But    B,C, 


A,C. 
Therefore  r, =32^ 


(Above) 


963.  The  Margin  of  Safety.  Other  cases  could  demonstrate  mathe- 
matically, as  the  diagram  does  graphically,  that  the  hypothetical 
margin  of  safety  grows  from  10  per  cent,  at  the  making  of  the 
mortgage  to  92  17-19  per  cent,  at  the  beginning  of  the  last  half  year. 
It  is  a  purely  hypothetical  margin,  however,  for  the  line  of  diminish- 
ing value  necessarily  is  not  straight,  but  composed  of  broken  curves 
determined  by  the  fluctuating  supply  and  demand  throughout  the 
entire  country  for  rolling  stock.  If  this  demand  during  a  heavy 
crop  movement  in  a  prosperous  year  should  become  acute,  it  is  quite 
possible  that  the  value  of  rolling  stock  that  had  not  become  over- 
worn, might  approach,  temporarily,  even  after  months  of  use,  its 
purchase  price,  or  under  converse  conditions,  might  make  a  much 
poorer  showing  than  the  diagram  indicates.  As  it  is,  depreciation 
the  first  year  must  be  abnormal,  for  once  a  car  is  used  at  all  it  be- 
comes second-hand  and  must  be  priced  accordingly.  But  the  diagram 
and  figures,  as  a  whole,  are  useful.    They  show  that  for  a  short  term 


EQUIPMENT  TRUST  OBLIGATIONS  311 

investment  the  later  maturities,  bought  when  an  issue  has  been 
long  outstanding,  have  a  greater  margin  of  safety  than  the  earlier 
maturities  of  a  newer  issue — indeed  many  times  as  great.  The  his- 
tory of  equipments  in  reorganization  bears  this  out.  In  this  dia- 
gram the  minimum  original  cash  equity  and  minimum  of  life  for 
the  rolling  stock  are  assumed ;  in  case  of  greater  original  cash  pay- 
ment and  greater  equipment  longevity  the  showing  would  be  very 
much  better. 

964.  Variations  in  Form.  The  Vanderbilt  system  has  recently 
floated  a  130,000,000  equipment  loan  that  varies  in  several  respects 
from  the  normal  type.  The  maturities,  which  are  annual,  are  dis- 
tributed over  a  period  of  fifteen  years,  with  what  loss  to  the  material 
security  of  the  loan  a  mental  readjustment  of  the  diagram  will 
show.  In  this  case  the  loss  is  compensated  for  by  the  guarantees  of 
four  of  the  Central's  subsidiary  companies.  A  more  radical  de- 
parture from  the  type  is  that  of  the  Delaware  and  Hudson,  which 
in  1907  issued  an  equipment  loan  maturing  in  1922  that  substituted 
a  sinking  fund  for  the  usual  semi-annual  repayments.  This  is  to  be 
regretted,  since,  apart  from  the  dangers  attendant  upon  sinking 
funds  in  general,  it  opens  the  way  for  further  inroads  into  the 
integrity  of  the  perfect  form,  namely,  the  ten-year,  semi-annual, 
serial  bond,  protected  with  at  least  a  ten  per  cent,  cash  equity.  As 
it  is,  we  are  threatened  with  redeemable  equipment  issues  and 
already  have  car  trusts  not  intended  for  public  absorption, 
but  for  use  as  collateral.  It  is  even  possible  that  junior  equip- 
ment liens,  trolley  equipment  liens,  or  other  departures  from 
the  norm  may  be  devised,  though  that,  perhaps,  is  borrowing 
trouble. 

965.  In  view  of  the  preferential  claim  of  equipment  obligations 
on  earnings,  and  of  the  splendid  history  of  equipments  when  put  to 
test,  the  question  naturally  arises,  why  do  such  strong  bonds  yield 
a  comparatively  high  rate  of  interest,  approximately  one-half  per 
cent,  higher  than  good  railroad  mortgage  bonds.  Largely  because 
they  are  not  thoroughly  appreciated. 

966.  Investment  Keturn :  Popular  Prejudice.  Equipment  bonds  are, 
as  we  have  said,  the  outgrowth  of  the  railroads'  impecuniosity. 
Necessity  has  seldom  mothered  a  better  fiscal  invention.  But  since, 
in  the  old  days,  the  bonds  nearly  always  found  their  way  into  the 
strong  boxes  of  moneyed  institutions,  the  recollection  among  older 
investors  of  the  necessity  of  the  railroads  has  been  stronger  than 
that  of  the  goodness  of  the  invention.     Furthermore  the  security 


312  EQUIPMENT  TRUST  OBLIGATIONS 

is  a  chattel  mortgage,  and  by  reason  of  this  classification  the 
bonds  are  frequently  condemned.  Or  if  not  in  point  of  law,  the 
bonds  have  Buffered  in  popular  estimation  by  reason  of  the  sort 
of  material  security  they  offer.  Rolling  stock  deteriorates  rapidly, 
may  be  lost,  stolen,  or  destroyed  by  fire,  derailment,  and  collision, — 
these  are  common  objections;  the  provisions  against  such  misfor- 
tunes are  not  appreciated;  and  the  ignorance  of  the  many  is  yet 
the  opportunity  of  those  who  invest  knowingly.  From  miscon- 
ceptions and  ignorance,  too,  equipment  bonds  are  not,  as  a  rule, 
eligible  for  savings  bank  investment  in  those  states  that  exercise 
close  supervision  in  such  matters,  and  this  being  the  case,  are  not 
favored  by  trustees  of  estates. 

967.  Competitive  Demand.  But  the  fundamental  reason  for  the 
high  yield  is  the  short  life.  It  must  be  remembered  that,  al- 
though the  normal  type  is  the  ten-year  bond,  it  is  serial  in  form, 
and  the  average  life  of  the  several  maturities  is  only  five  years, 
and  therefore  any  one  issue  has  little  opportunity  to  become  widely 
known  and  to  have  its  value  enhanced  by  competitive  demand.  The 
shorter  the  life  of  a  security  the  less  its  potentiality  for  increase 
in  value.  Since  it  is  essential  that  the  standard  duration  be  short, 
probably  equipment  issues  will  always  present  a  higher  return  than 
do  high  class  mortgage  railroad  bonds  of  long  life.  One  may  then, 
in  virtue  of  security  and  yield,  recommend  the  purchase  of  equip- 
ment issues  of  the  present  standard  when  longevity  is  not  a  require- 
ment of  the  investment. 

968.  Growth  in  Favor.  At  the  present  time  there  is  a  difference 
of  nearly  one-half  per  cent.,  as  we  have  said,  between  the  average 
income  yield  of  equipment  and  the  better  railroad  mortgage  bonds. 
As  the  virtues  of  the  former  become  more  widely  recognized  this 
discrepancy  will,  no  doubt,  be  somewhat  reduced.  Equipments  are 
growing  in  favor  very  rapidly.  Whereas  a  half-dozen  years  ago  some 
bond  houses  and  many  bond  salesmen  seem  uninformed  of  the  exact 
status  of  this  form  of  investment,  now  it  is  the  public  only  that 
needs  to  be  taught,  and  bankers  and  financial  periodicals  are  seeing 
to  it  that  information  upon  the  subject,  intelligently  gathered  and 
ably  presented,  shall  not  be  wanting.  When,  within  four  months 
of  the  1907  panic,  the  New  York  Central  Lines  could  dispose,  with 
6clat,  of  about  $30,000,000  of  equipments  in  a  fortnight  or  so  upon 
a  public  in  anything  but  an  investing  mood,  the  battle  for  popular 
recognition  might  be  said  to  be  nearly  won,  especially  when  it  is 
remembered   that  not  many  years  since  there  was  scarcely  three 


EQUIPMENT  TRUST  OBLIGATIONS  313 

times  that  amount  of  the  bonds,  altogether,  in  the  hands  of  the 
public. 

It  is  to  be  hoped  that  the  future  great  equipment  issues,  which 
will  run  into  eight  figures,  will  not  depart  radically  from  the  per- 
fect norm  that  experience  has  found  so  safe  and  satisfactory. 


CHAPTER  XXIV 
STEAMSHIP  BONDS 

969.  Steamship  Bonds  naturally  find  a  place  among  the  loans 
of  transportation  companies,  although  they  have  no  prominence  as 
a  type  of  security.  The  body  of  investment  principles  which  char- 
acterize and  differentiate  them  is  small ;  and  the  application  of 
principles  peculiar  to  them  is  rendered  difficult  by  the  variety  of 
conditions  under  which  steamship  companies  operate. 

970.  Blanket  Mortgage  Steamship  Bonds.  Those  issues  which  can 
be  most  nearly  judged  as  we  should  weigh  many  of  the  other  types 
of  private  corporation  bonds,  are  blanket  mortgages,  the  obligations 
of  companies  operating  several  or  many  vessels,  and  possibly  operat- 
ing in  many  waters.  We  should  expect  the  mortgage  to  be  a  first 
lien,  and  the  company  to  have  a  satisfactory  record  of  earnings 
derived  from  a  kind  of  traffic  that  is  steady  and  promising. 

971.  Equities.  The  valuation  of  the  ships,  docks,  terminal  build- 
ings, or  other  property  of  the  company  under  the  mortgage,  should  be 
the  estimate  of  disinterested  appraisers,  and  should  show  an  equity 
of  about  100  per  cent,  over  the  authorized  amount  of  the  bonds. 
It  is  best  for  the  maintenance  of  the  equity  that  the  vessels  be  new, 
or  nearly  so.  Any  bonds  in  escrow  should  be  issued  for  additional 
property  only  to  about  75  per  cent,  of  its  value. 

972.  II  is  very  desirable  that  the  bond  issue  mature  serially, 
especially  if  much  of  the  equipment  is  not  new.  The  action  of 
water,  fresh  or  salt,  is  not  favorable  to  material  property,  and  de- 
terioration is  rapid.  Changes  in  marine  transportation,  both  en- 
gineering and  commercial,  are  rapid,  and  transfer  by  sea  or  lake 
is  not  a  natural  monopoly.  Therefore  the  margin  of  safety  should 
be  increased,  annually,  by  the  serial  retirement  of  the  bonds. 

973.  Insurance.  Insurance  in  favor  of  bondholders  is  a  factor 
of  safety  for  almost  any  kind  of  funded  corporation  loan.  It  is 
desirable  as  collateral  for  equipment  bonds.  If  there  are  insurable 
buildings  or  plants,  it  is  essential  to  timber  and  real  estate  bonds. 
But  it  is  the  very  life  of  the  security  for  steamship  bonds. 

974.  It  is  customarily  provided  that  insurance  covering  all  the 

314 


STEAMSHIP  BONDS  315 

property  shall  be  maintained  in  amount  25  per  cent,  in  excess  of 
the  mortgage.  But  this  is  not  necessarily  sufficient.  The  policies 
should  be  deposited  with  and  made  payable  to  the  trustee  for  the 
bondholders.  They  should  cover,  not  only  land  hazards,  and  the 
ordinary  marine  dangers  of  fire,  collision,  stranding,  sinking,  etc., 
but  also  afford  protection  against  claims  for  damage  done  to  other 
vessels,  to  docks,  bridges,  and  any  fixed  or  floating  property. 

975.  The  mortgage  should  make  provision  for  the  disposition  of 
any  insurance  moneys  paid  in: — either  arranging  for  the  replace- 
ment of  the  property  destroyed,  and  requiring  that  the  steamship 
company  should  pay  the  difference  between  the  cost  of  the  new 
property  and  the  amount  of  insurance  obtained,  or  else  reinforcing 
the  security  for  the  bond  issue  by  diverting  this  money  to  the  sink- 
ing fund. 

976.  Mr.  Mortgomery  Kollins  has  quoted  some  legal  principles 
which  apply  to  the  mercantile  marine.1    They  are  as  follows : 

"  The  liability  of  the  owner  of  a  vessel  for  loss  or  damage  to  another  vessel 
or  to  the  cargo  of  either  vessel,  happening  through  errors  in  navigation  or 
management,  or  from  perils  of  the  sea,  but  without  his  knowledge  or  privity, 
is  limited  to  the  value  of  his  vessel,  and  the  freight  then  earned,  in  the  condi- 
tion in  which  it  is  after  the  happening  of  the  loss  or  accident. 

"  The  owner  is  also  not  liable  for  loss  or  damage  by  fire  to  the  cargo  carried 
in  his  own  vessel  unless  caused  by  his  own  neglect. 

"  If  the  owner  exercise  due  diligence  to  make  his  vessel  seaworthy  and  to 
see  that  she  is  properly  manned  and  equipped,  neither  he  nor  his  vessel  is 
liable  for  loss  or  damage  to  the  cargo  carried,  from  errors  of  navigation  or 
management,  or  from  dangers  of  the  sea. 

"  The  owner  may  relieve  himself  of  all  liability  by  transferring  all  his  inter- 
est in  the  vessel  and  the  freight  then  pending  to  a  trustee  for  all  claimants. 

"  It  follows  that  the  owner  is  not  personally  liable  if  his  vessel  becomes  a 
total  wreck. 

"  Insurance  on  the  vessel,  recovered  by  the  owner,  is  no  part  of  the  owner's 
interest  in  the  vessel,  and  is  not  liable  to  be  taken  to  pay  for  the  loss  or 
damage. 

"  The  owner  of  a  vessel  is  of  course  personally  liable,  without  limitation,  if 
the  loss  is  attributed  to  his  own  fault  or  negligence. 

"  In  case  of  a  corporation,  the  '  knowledge  and  privity '  which  would  make 
it  liable  must  be  the  knowledge  and  privity  of  its  officers  or  managers,  and 
not  of  the  masters  of  its  vessels." 

977.  Management.  So  much  of  steamship  freight  traffic  is  derived 
from,  or  tributary  to,  other  systems  of  transportation,  notably  the 
railroads,  that  it  is  desirable  to  know  the  standing  and  affiliations 

1  Money  and  Investments,  Boston,  1907,  pp.  375-376. 


316  STEAMSHIP  BONDS 

of  the  management.  Affiliation  usually  may  be  traced  by  stock 
ownership — back  to  the  company  or  interests  which  own  the  capital 
stock,  or  forward  to  the  subsidiary  steamship  or  other  companies 
which  are  controlled  by  stock  ownership. 

978.  Affiliations  are  particularly  important  because  steamship 
lines  control  no  right  of  way  and  have  no  natural  monopoly. 

979.  "  Single  Boat  Bonds."  When  the  bonds  are  secured  by  lien 
upon  only  one  boat  it  is  obvious  that  its  physical  excellence  must 
be  the  object  of  close  scrutiny.  Yet  it  is  by  no  means  to  be  inferred 
that  any  inferiority  attaches  to  the  single  boat  type.  In  many,  if 
not  most  cases  of  this  sort,  the  obligor  company  is  owner  of  only 
one  or  two  boats.  Although  the  capital  of  the  company  may  have 
been  fully  paid  in,  and  the  amount  may  have  been  approximately 
equal  to  the  bonded  indebtedness,  nevertheless,  after  paying  neces- 
sary organization  expenses  (including  the  purchase  of  wharfage 
facilities  and  rights),  the  stock  does  not  represent,  in  event  of  fail- 
ure, much  merchantable  property  except  the  equity  in  the  boat  itself. 

980.  Steamship  Bonds  of  the  Great  Lakes.  "  Single  Boat  Bonds,'' 
if  we  may  coin  this  expression,  are  studied  at  their  best  in  the  case 
of  the  grain-  and  freight-forwarding  companies  of  the  Great  Lakes. 
These  loans  deserve  mention  because  of  their  particular  excellence, 
and  because  of  the  amount  of  them  that  have  been  put  on  the  market. 
They  are  held  in  sufficient  esteem  by  the  State  of  Michigan,  which 
ought  to  know,  for  the  legislature  to  make  them  legal  for  savings 
banks. 

981.  The  Michigan  law  is  given  below,  in  full,  because  it  is  such  an 
excellent  summary  of  the  investment  principles. 

Act  2G2,  P.  A.,  1905,  as  amended  by  Act  480,  P.  A.,  1907,  Section 
27,  provides  that  a  savings  bank  may  invest  any  part  of  three-fifths 
of  its  total  deposits  in  certain  kinds  of  municipal  and  corporation 
bonds;  and 

(g)  "in  the  legally  authorized  first  mortgage  bonds  of  steamship  companies: 
Provided,  That  such  mortgages  shall  be  upon  steel  steamship  or  steamships  for 
the  carriage  of  freight  or  package  freight  and  passengers  combined,  upon  the 
Great  Lakes  and  connecting  waters,  of  at  least  five  thousand  tons  carrying 
capacity  each:  Provided,  Such  bonds  are  issued  at  the  time  of  completion  and 
enrollment  of  such  steamship  or  steamships,  or  within  one  year  thereafter:  and 
Provided  further,  That  by  the  express  terms  of  said  mortgage,  at  least  ten 
per  cent,  of  the  total  issue  of  said  bonds  shall  be  retired  annually,  beginning 
within  two  years  from  the  date  of  said  bonds,  and  that  the  mortgage  liability 
against  said  property  shall  not  exceed  one-half  of  its  actual  cost:  and  Provided 
further,   That  the   trustees  of   such   mortgage   shall   be   required   to   protect   the 


STEAMSHIP  BONDS  317 

lien  of  said  mortgage  by  attending  to  the  recording  thereof  and  by  causing 
property  covered  by  said  mortgage  to  be  insured  against  all  risks  on  vessel 
property  ordinarily  covered  by  such  insurance,  including  marine  risks  and  disas- 
ters, general  and  particular  average,  collision  liability,  protection  and  in- 
demnity insurance,  and  insurance  against  liability  for  injuries  to  persons, 
in  insurance  companies  and  under  forms  of  policies  approved  by  the  trustees, 
for  an  amount  equal  to  the  full  insurable  value  of  such  steamship,  such  insur- 
ance to  be  made  with  such  loss  payable  to  said  trustee,  and  the  policies  deposited 
with  it:  and  Provided  further,  That  there  shall  be  filed  with  the  commissioner 
of  the  banking  department  of  this  state  a  schedule  of  the  insurance  upon  such 
property,  which  schedule  shall  be  signed  by  the  trustee  under  said  mortgage 
and  shall  be  accompanied  by  the  certificate  of  said  trustee  that  the  policies 
mentioned  in  the  said  schedule  are  held  by  said  trustee  and  are  payable  to 
said  trustee  in  case  of  loss  for  the  benefit  of  the  holders  of  the  outstanding 
bonds  issued  under  such  mortgage;  and  further,  that  similar  certificates  be 
filed  from  time  to  time  by  said  trustee  with  said  commissioner  of  the  banking 
department  of  this  state,  evidencing  renewals  of  said  insurance  by  proper  poli- 
cies or  legal  insurance  binders:  Provided  further,  That  by  the  terms  of  such 
mortgage,  the  mortgagor  shall  not  suffer  such  steamship  to  become  indebted 
in  an  amount  exceeding  five  per  cent,  of  the  original  amount  of  the  principal 
of  said  mortgage  at  any  time  and  that  the  failure  of  the  mortgagor  to  forth- 
with secure  the  release  of  such  steamship  or  steamships  from  mechanics',  labor- 
ers', admiralty,  statutory  or  other  liens,  claims  or  charges  against  such  steam- 
ship, shall  constitute  a  default  in  the  provisions  of  such  mortgage:  and  Provided 
further,  That  such  bonds  shall  have  been  approved  by  the  securities  commission 
hereinafter  provided  for." 

982.  Their  Record.  An  editorial  in  the  Marine  Review 1  com- 
ments :  "  Since  the  trust  companies  of  the  Great  Lakes  began 
dealing  in  this  form  of  security,  over  f  15,000,000  worth  of  bonds  have 
been  sold,  and  there  is  yet  to  be  related  a  single  instance  wherein 
one  of  them  defaulted  in  its  interest  account."  The  Editor  of  the 
Review  informs  the  writer  that  since  this  article  was  written,  179 
bulk  freighters  have  been  launched  on  the  Great  Lakes,  practically 
all  of  them  bonded.  Presumably  the  exceptions  to  bonding  are  the 
ore  ships  of  the  big  steel  companies.  By  this  building,  approximately 
140.000,000  of  new  steamship  securities  have  been  floated,  and  as 
yet  there  has  been  no  default. 

983.  There  is  a  marked  and  highly  desirable  uniformity  of  con- 
ditions under  which  the  steamship  bonds  of  the  Great  Lakes  are 
being  issued.  The  boats  pledged  are  steel  clad  vessels,  of  Al  rating 
in  the  Registers,  designed,  say  to  carry  down  cargoes  of  wheat  from 
Duluth  to  Buffalo,  and  return  between  decks  cargoes  of  package 
freight.     They  may  be  steel  freighters  built  to  carry  ore  eastward 

1  Detroit,  January  26,  1906. 


318  STEAMSHIP  BONDS 

from  the  mines  of  the  Messaba  district.     They  may  be  coalers  or 
other  carriers  of  the  enormous  Great  Lake  traffic. 

984.  The  life  of  a  steel  clad  steamship  is  estimated  at  GO  years. 
The  classification  societies  will  give  such  steamship  an  A  1  rating 
for  20  years,  and  upon  observance  of  certain  conditions  will  renew 
the  rating  for  a  like  period.  The  bonds,  issued  in  amount  to  about 
one-hall'  of  the  cost  of  the  vessel,  mature  within  ten  years  in  about 
equal  annual  series.  The  equity,  therefore,  grows  more  rapidly  than 
in  the  case  of  equipment  bonds. 

985.  Insurance.  The  necessities  of  ample  insurance  protection 
are  even  more  easily  realized  in  the  case  of  these  single  boat  bonds. 
It  should  be  imperative  by  the  terms  of  the  mortgage  that  the 
general  insurance  itself  considerably  exceed  the  bonded  indebted- 
ness and  cover,  not  only  the  liabilities  of  collision,  sinking,  etc., 
previously  mentioned,  but  also  the  breaking  of  machinery  and  burst- 
ing of  boilers,  and  any  hurt  to  the  vessel  through  the  negligence  of 
master  or  crew. 

986.  In  addition  to  full  general  insurance,  the  vessel  will  carry 
protection  and  indemnity  insurance  against  liability  for  loss  of 
life  or  personal  injury.  The  bond  circular  should  state  the  re- 
spective amounts  of  general  and  indemnity  insurance,  and  the  mort- 
gage should  stipulate  the  minimum  of  each  permitted.  It  is  to  be 
doubted  if  the  terms  of  the  mortgage  are  usually  strict  enough 
or  explicit  enough,  for  frequently  the  interest  of  the  owners  makes 
them  carry  an  insurance  in  excess  of  the  requirement. 

987.  Earnings.  The  supervision  of  the  trustee  will  extend  beyond 
matters  of  insurance.  The  trust  company  will  see  to  it  that  the 
company  owning  the  vessel  does  not  contract  a  temporary  indebted- 
ness in  excess  of  the  necessary  operating  expenses.  As  a  rule  the 
mortgage  limits  this  amount  to  $1,000.  The  trust  company  will  re- 
quire that  a  statement  of  the  earnings  and  expenses  of  the  vessel 
be  returned  to  it,  say  quarterly,  in  order  that  it  may  know  how  the 
vessel  is  being  managed. 

Another  way  in  which  the  mortgage  may  require  that  the  vessel 
operate  on  practically  a  cash  basis  is  by  providing  that  it  may 
become  indebted  in  an  amount  not  more  than  5  per  cent,  of  the  bonds. 

988.  The  construction  of  new,  or  the  extension  of  the  present 
systems  of  transportation  by  rail,  canal,  or  river,  cannot,  it  seems, 
cripple  the  freight  business  of  the  Great  Lakes  for  many  years  to 
come,  at  least,  and  so  endanger  the  earning  power  of  vessels  now 
being  built  and  bonded.    Ore  will  continue  to  be  dug,  and  wheat 


STEAMSHIP  BONDS  319 

to  be  cut,  in  the  Northwest,  long  after  all  the  outstanding  loans 
have  matured. 

989.  New  standards  of  luxury  may  call  for  the  relegation  of 
passenger  boats  to  inferior  and  less  profitable  service,  but  freight 
carriage  is  independent  of  fashion,  and  governed  by  laws  almost 
mathematical. 

990.  But  even  if  it  is  conceivable  that  the  Lake  traffic,  passenger 
or  freight,  could  diminish  to  the  extent  of  making  certain  lines 
unprofitable,  there  are  other  waterways  adapted  to  the  same  service. 
Whalebacks,  through  prejudice  or  inadaptability,  and  other  special 
and  abortive  types,  might  encounter  greater  resistance  to  occupancy 
of  other  waters,  but  the  prospect  is  remote.  Moreover,  every  year 
diminishes,  by  about  10  per  cent.,  the  necessary  interest  of  the  bond- 
holders in  the  future  of  Lake  transportation. 

Perhaps  these  notes  on  a  certain  kind  of  steamship  company  and 
its  bonds  may  be  helpful  in  directing  the  bond  buyer's  lines  of 
inquiry,  when  loans,  from  other  quarters,  of  steamship  companies 
operating  under  other  conditions,  are  offered  him  for  investment. 


CHAPTER  XXV 
STREET  RAILWAY  BONDS 

991.  Nothing  more  clearly  illustrates  the  immature  condition  of 
the  science  of  bond  investment  than  lack  of  precision  in  its  nomen- 
clature. The  preliminary  steps  in  an  inductive  development  of 
any  science  are,  of  course,  examination,  description,  and  division 
or  classification.  It  is  at  the  point  of  classification,  that  necessity 
arises  for  an  exact  terminology.  It  matters  little  whether  plants, 
minerals,  or  securities  are  under  examination,  the  use  of  proj)erly 
labeled  inscriptions  for  the  specimens,  or  the  lack  of  use,  is  a  matter 
of  moment  to  progress  in  the  study. 

992.  The  Title.  At  this  point  we  want  for  a  proper  title  to  give 
the  bonds  of  railway  transportation  concerns  that  are  not  steam 
railroad  companies.  As  yet  there  is  no  uniformity  of  custom. 
"  Electric  Traction  Bonds,"  "  Electric  Railway  Bonds,"  and  "  Trol- 
ley Bonds  "  seem  fairly  inclusive  and  descriptive  appellations,  and 
have  some  vogue,  but  the  cable  is  not  yet  obsolete  and  the  third- 
rail  is  receiving  more  attention  as  time  goes  on.  An  objection  of 
greater  weight  is  that  the  distinction  between  electricity  and  steam 
as  motive  power  will  not  serve  many  years  longer  to  separate  the 
present  two  great  kinds  of  transportation.  But  this  is  anticipating. 
The  United  States  Census  Service  entitles  its  special  report  "  Street 
and  Electric  Railways  in  the  United  States,"  and  embraces  "  all  elec- 
1  iic  railways  irrespective  of  their  length  or  location  and  all  street 
railways  irrespective  of  their  motive  power."  As  this  report  is  the 
most  comprehensive  single  survey  of  the  field  and  furnishes  us  with 
the  greater  part  of  our  statistics  in  this  chapter,  it  is  well  to  re- 
member that  its  title  and  scope  are  a  little  too  broad  to  demarcate 
exactly  the  class  of  securities  we  have  in  mind. 

993.  On  the  whole,  the  most  acceptable  phrase,  perhaps,  is  that  in 
use  on  the  exchanges :  "  Street  Railway  Bonds,"  meaning  by  this 
the  bonds  of  all  transportation  companies  (irrespective  of  motive 
power),  the  rails  of  which,  whether  laid  on,  below,  or  above  the 
streets,  or  on  private  right-of-way  in  open  country,  bear  freight  and 
passengers  as  lighter  local  traffic,  or  as  traffic  tributary  to  cen- 

320 


STREET  RAILWAY  BONDS  321 

ters    of    population,    or    tributary    to    long    haul    steam    railroad 
traffic. 

994.  Variety  of  Kinds.  No  other  securities  commonly  classed  to- 
gether  except  "  Industrial  Bonds  "  represent  so  many  and  such 
varied  activities  as  these.  In  this  respect  they  are  the  opposite  of 
gas  bonds.  The  gas  industry  is  old,  its  technical  and  financial 
problems  are  simple,  well  understood,  and  reasonably  uniform 
throughout  the  country.  The  principles  of  gas  investment,  there- 
fore, are  easy  to  develop  and  apply.  It  is  not  hard  to  purchase  gas 
bonds  wisely.    The  same  holdttuf  equipment  Donds,  except  that  these 

latter  want  the  ripening  of  age  that  one  hundred  years  of  life  have 
given  to  gas  securities.  Street  railway  transportation  is  not  only 
more  complicated  in  its  characteristics  and  problems  than  gas- 
manufacturing,  or  car-building,  but  it  lacks  maturity  and  experi- 
ence also.  Its  future,  therefore,  is  not  ascertained,  and  it  has  not 
yet  had  enough  in  common  with  steam  railroading  to  have  taken 
over  from  that  business,  as  conducted  in  this  country,  the  body  of 
financial  principles  learned  through  a  half-century  of  vicissitude. 
So,  at  best,  any  generic  treatment  of  street  railway  bonds  will  be 
unsatisfactory  from  the  bond  buyer's  standpoint,  for  little  can  be 
said  that  will  be  immediately  helpful  to  a  wise  choice  of  securities. 
It  requires  study  and  a  nice  discrimination  to  purchase  street  rail- 
way bonds  without  subsequent  regret.  However,  something  is  ac- 
complished toward  the  desired  result  if  one  informs  himself  as  to 
the  history  and  present  status  of  the  industry. 

995.  History:  the  Urban  Road.  Electric  railroading  began  in 
1888  as  an  improvement  upon  animal  traction  in  cities.  The  history 
of  its  development  for  the  next  ten  or  twelve  years  was  the  history 
of  its  gradual  emancipation  from  the  function  of  improved  sub- 
stitute for  the  horse  car  line  and  its  establishment,  physically  and 
financially,  upon  the  basis  of  its  own  peculiar  strength  and  limita- 
tions as  a  means  of  urban  transportation.  At  the  end  of  this 
period  it  might  have  been  said  to  owe  nothing  to  its  predecessor  but 
the  fare  register  and  the  franchise. 

996.  The  Intemrban.  In  1895  came  the  interurban  trolley.  In 
its  decade  of  predominance  it  passed  through  the  same  set  of  phases : 
from  imitation  of  its  predecessor,  the  urban  trolley,  through  rough 
experience,  to  independent  self-development  as  a  distinct  class  of 
transportation. 

997.  At  first,  however,  the  relation  between  street  and  interurban 
railways  was  much  closer  than  between  interurban  and  steam  roads 


322  STREET  RAILWAY  BONDS 

as  to  character  of  equipment  and  roadbed,  kind  of  transportation 
service  rendered,  and  methods  of  financing.  So  the  two  electric 
modes  drew  together  and  at  the  beginning  of  the  new  century  their 
coalition  was  a  thing  generally  accomplished;  and  the  development 
from  coalition  to  absolute  merging  with  its  consequent  virtual  loss 
of  identity  for  the  constituent  divisions  has  since  been  going  on  as 
rapidly  as  ever  in  the  preceding  decades  it  went  on  among  the 
smaller  railroads  toward  the  upbuilding  of  the  great  transcon- 
tinental systems. 

998.  Interurban  Centers.  Around  the  chief  electric  railway  in  each 
community  as  nucleus  the  outlying  roads  became  grouped  as  feeders, 
and  each  group  so  formed  served  in  turn,  of  course,  the  larger 
territorial  scheme  through  its  interurban  connections.  At  present 
there  are  great  interurban  centers  at  Chicago,  Indianapolis,  Dayton, 
Detroit,  Toledo,  Cleveland,  Columbus,  Cincinnati,  and  Boston;  and 
we  have  (or  had)  our  interurban  Gould  and  Huntingdon  dispen- 
sations in  the  Everett-Moore,  Pomeroy-Mandelbaum,  and  Appleyard 
syndicates. 

999.  Geography  has  played  a  very  important  part  in  this  de- 
velopment. Almost  all  the  great  electric  railway  systems  are  to  be 
found  in  the  New  England  states,  Pennsylvania,  Ohio,  Indiana,  Illi- 
nois, and  Wisconsin.  The  geographical  situation  suggests  that 
under  normal  conditions  well-settled  districts  having  towns  and 
cities  scattered  about  with  a  fifty-mile  radius  are  necessary  as  nodi 
to  a  successful  interurban  network,  for  these  are  the  conditions 
that  imply  a  high  I  density. 

1000.  The  Western  Development:  Competitive.  The  last  stage  in 
the  purely  interurban  phase  of  electric  transportation  development 
was  the  adoption  of  steam  railroad  characteristics:  level,  heavily 
ballasted  roadbed  with  low  gradients,  heavy  steel  rails,  Pullman 
dining  and  sleeping  coaches,  large  terminal  office  buildings,  the 
upbuilding  of  parcel  and  merchandise  service,  the  issuance  of 
through,  excursion,  and  commutation  tickets, — all  these  features 
of  mature  steam  transportation  have  been  employed  in  the 
Lake  states,  and  often  with  success,  to  draw  on  sources  of  revenue 
that  otherwise  would  go  to  the  railroads. 

This  may  be  called  the  Western  interurban  phase.  It  is  more 
picturesque  than  the  Eastern,  and  consequently,  has  received  more 
attention  through  periodical  literature.  It  is  a  question,  however, 
if  it  be  not  the  less  important. 

1001.  By   popular   diffusion   of   financial    intelligence,    perhaps 


STREET  RAILWAY  BONDS  323 

by  force  of  economic  necessity,  we,  as  a  people,  have  become  partly 
reconciled  to  the  development  of  transportation  along  monopolistic 
lines.  Regulation  by  commission,  we  have  come  to  believe,  will 
serve  to  curb  the  evils  that  a  natural  monopoly  fosters ;  the  Judici- 
ary and  Executive  draw  a  fine  line  in  the  definition  of  railroad 
competition ;  there  is  still  a  hue  and  cry  at  each  new  consolidation, 
and  the  railroads  still  deem  it  necessary  to  take  the  preliminary 
steps  toward  further  grouping  with  the  secrecy  of  conspirators; 
but  organized  opposition  is  now  largely  to  serve  either  political  or 
corporative  ends.  Again,  however,  as  the  result  of  popular  will 
or  through  economic  causes,  or  both,  natural  monopolies  at  present 
tend  to  grow  by  process  more  of  agglutination  than  of  fusion. 
That  is  to  say  the  constituent  companies  tend  to  preserve  a  larger 
measure  of  autonomy  and  individuality  than  formerly.  In  rail- 
roading the  catchword  for  this  recent  tendency  is  "  community  of 
interest,"  by  which  the  results  without  the  odium  of  exclusive 
possession  are  achieved.  So  the  fact  remains,  and  is  tacitly  con- 
ceded by  the  public,  that  the  business  of  transportation  properly 
performed  is  of  necessity  monopolistic. 

1002.  Into  this  present  order  of  things  the  Western  development 
of  interurban  units  actively  competing  with  steam  roads  does  not 
seem  to  fit.  In  so  far  as  electric  traction  in  the  West,  with  its 
vastly  more  adjustable  service,  is  able  to  fill  a  different  order  of 
wants:  carry  small  merchandise  and  garden  truck  to  market, 
search  into  territory  not  reached  by  railroads  and  gather  primitive 
traffic — it  is  doing  sound  business.  But  the  ultimate  interests  of 
the  community  are  not  served  where  steam  and  electricity  fight 
side  by  side  for  intercity  business,  both  freight  and  passenger. 

1003.  Competition  of  this  kind  has  been  keenest  in  Ohio.  On 
a  priori  grounds  one  would  expect,  for  electric  roads,  at  least 
temporary  advantage.  Their  fares  average  about  two-thirds  those 
of  steam  roads,  their  through  service  is  often  as  speedy  and  almost 
always  more  frequent,  comfortable,  and  cleanly,  and  they  usually 
discharge  their  passengers  at  more  convenient  points  in  the 
terminal  centers.  The  classic  illustration  of  the  result  upon 
railroad  earnings  is  from  the  Lake  Shore  and  Michigan  Southern.1 
The  Lake  Shore  is  paralleled  by  a  high-speed  electric  line  from 
Cleveland  to  Painesville,  a  distance  of  30  miles.  In  1895,  before 
the  completion  of  the  electric  line,  the  average  number  of  passen- 

1  F.  T.  Carlton,  Yale  Review,  August,  1904. 


324  STREET  RAILWAY  BONDS 

gers  carried  per  month  by  the  Lake  Shore  between  the  two  cities 
and  intermediate  points  was  16,600;  in  L902  it  was  2,500.  Al- 
though this  statement  is  not  representative  it  prepares  us  to  learn 
that  in  1905  the  electric  roads  in  Ohio,  reporting  (two-thirds  of 
the  entire  mileage),  earned  ostensibly,  above  all  charges,  10  per 
cent,  upon  their  total  outstanding  stock. 

1004.  The  1007  report  of  the  Census  Bureau  on  Street  and 
Electric  Railways  gives  the  gist  of  answers  to  some  inquiries  sent 
to  34  steam  railroads  regarding  the  effect  of  electric-railway  com- 
petition. From  these  we  learn  that  almost  every  railroad  experi- 
ences a  loss  in  business,  four  or  five  losing  from  90  per  cent,  to 
all  of  the  short  haul  passenger  traffic.  Railroad  freight  traffic, 
however,  has  suffered  little. 

1005.  The  trolleys'  gain  in  Ohio  and  other  Central  states  was 
not  utterly  the  railroads'  loss.  Much  riding  on  electrics  is  done 
at  first  for  the  mere  novelty,  and  ultimately  reverts  to  the  steam 
roads.  Much  of  trolley  traffic,  as  we  have  said,  results  from  the 
creation  of  new  wants  made  appreciable  by  the  means  for  satisfy- 
ing them.  By  supplying  good  suburban  service  the  suburbs  are 
enlarged  and  multiplied,  the  "  trolley  habit "  is  formed,  and  so 
transportation  business  is  created  as  well  as  diverted. 

But,  at  best,  the  relation  between  electric  and  steam  traction 
in  the  West  is  a  competitive  relation,  and  being  such,  the  present 
state  of  the  Western  interurban  systems  is  probably  transitional. 
What  will  eventuate  can  only  be  surmised,  but  possibly  a  clue  to 
the  outcome  may  be  had  from  New  England. 

1006.  When  President  Mellen  came  East  to  assume  direction 
of  the  New  York,  New  Haven,  and  Hartford  the  trolleys  of  New 
England  were  a  most  sporadic  group  of  companies  working  at 
sixes  and  sevens  and  developing  in  the  haphazard  fashion  that 
enterprises  will  when  they  lack  the  direction  of  an  informing 
purpose.  In  the  last  few  years,  in  the  face  of  well-grounded,  per- 
haps well-meant,  but  nevertheless  misdirected  opposition,  he  has 
brought  comparative  order  out  of  the  chaos,  and  through  the 
agency  of  holding  companies  in  Connecticut,  Massachusetts,  and 
Rhode  Island,  has  so  organized  and  extended  eiectric  traction 
service  that  all  people  have  benefited. 

1007.  The  Eastern  Development:  Saturative.  We  are  not  con- 
cerned with  the  legal  aspects  of  the  contention  that  has  arisen 
between  the  New  Haven  and  the  Commonwealth  of  Massachusetts 
in  regard  to  the  New  Haven's  trolley  holdings,  but  it  is  season- 


STREET  RAILWAY  BONDS  325 

able  to  point  out  that  the  technical  separation  of  the  steam  and 
electric  systems  will  work  out,  as  the  New  Haven's  control  of  the 
Boston  and  Maine  seems  to  be  working  out,  in  an  extension  of  the 
agglutinative  rather  than  the  fusing  or  merging  policy, — but  always 
toward  greater  transportation  units:  more  monopoly. 

1008.  Mr.  Mellen's  designation  for  the  system  of  trolley  develop- 
ment he  has  devised  is  appropriate:  he  calls  it  "  sarnrntion.v  that 
is  to  say,  within  the  territory  served  by  the  New  Haven  road  the 
trolley,  practically  eliminated  as  competitor,  has  been  converted 
to  a  function  of  far  greater  capability  for  usefulness :  that  of  tribu- 
tary to  the  steam  roads.  In  every  physical  respect  the  trolley  is 
qualified  to  extend  to  minutest  ramifications  the  system  of  trunk 
line  and  connecting  and  subsidiary  branches  long  ago  established 
by  steam  roads,  and  so  "  saturating  "  a  territory  with  transporta- 
tion service.  The  trolley  is  commercially  and  physically  possible 
where  the  railroad  is  not.  Independent  of  grade  and  running  in 
single  units  and  therefore  more  frequently  and  without  the  expense 
and  detraction  of  drawing  its  own  power  generator  with  each  unit, 
capable  of  rapid  "  pick  up "  or  acceleration  for  service  between 
way  stations,  and  therefore  capable  of  running  its  cars  at  short 
intervals  with  safety,  it  is  no  wonder  that  the  railroads  would  some- 
times gladly  abandon  their  suburban  service  to  trolley  competitors 
or  allies,  were  it  possible,  especially  if  hard  pressed  for  adequate 
facilities  to  handle  through  traffic,  aud  hampered  in  suburban  rate- 
regulation  by  the  indirect  influence  of  low  trolley  tariffs.1 

1009.  So  the  success  of  the  New  Haven's  policy  of  assuming  the 
operation  of  the  trolleys  in  its  territory  is  of  extreme  importance  to 
the  public.  The  population  of  Connecticut  and  Rhode  Island  is  so 
ideally  distributed  that  in  those  states  the  working  of  this  trolley 
feeder  system  does  not  receive  its  most  convincing  test.  If,  however, 
one  will  examine  maps  of  Massachusetts,  such  as  accompany  the 
reports  of  the  Massachusetts  Railroad  Commission  each  year,  show- 
ing  the  routes,  built  and  projected,  of  electric  railways  in  the  state, 
he  will  observe  in  how  many  particulars  the  trolley  feeders  are  con- 
tributing toward  an  order  of  things  in  railroad  transportation  bet- 
ter than  we  have  yet  seen.  Should  he  take  the  pains  to  compare 
these  maps  for  the  past  few  years  he  will  have  the  best  possible 
graphic  exposition  of  what  the  New  Haven  Road  has  done  toward 

1  This  has  been  the  attitude  of  the  Boston  and  Maine,  if  President  Tuttle  is 
reported  correctly;  and  a  traffic  manager  of  the  Boston  and  Albany  has  so 
expressed  that  railroad's  position,  in  the  presence  of  the  writer. 


32G  STREET  RAILWAY  BONDS 

the  attainment  of  ideal  transportation  conditions.  He  will  note 
that  previous  to  Mr.  Mellen's  coming  in  1903,  the  trolley  roads, 
built  for  the  most  part  as  inde]>endent  units  and  therefore  under 
the  necessity  of  being  sell' subsist  cut,  were  either  urban  systems  or 
interurban  connecting  links  between  lines  of  towns  strung  along 
river  valleys.  This  was  particularly  true  in  the  western  half  of  the 
state.  These  lines  might  be  called  laterals,  for  almost  invariably, 
in  the  nature  of  the  case,  they  paralleled  the  steam  roads;  and 
although  bettering  the  accommodations  of  the  communities  they 
served,  to  some  extent  their  revenues  were  taken  out  of  the  legiti- 
mate earnings  of  the  steam  roads. 

1010.  Since  1903  these  laterals,  to  be  sure,  have  been  gradually 
extended,  especially  from  east  to  west  in  preparation  for  electric 
service  with  New  York  State;  but  in  addition  transverse  connec- 
tions, not  commercially  possible  under  independent  financing  except 
in  the  more  thickly  settled  eastern  parts  of  the  state,  are  uniting 
the  latitudinal  lines,  making  accessible  new  districts  probably  never 
to  be  reached  by  trains;  and  here  and  there  in  many  places,  town- 
ships that  never  before  saw  a  steel  rail  are  being  tapped  by  branch 
trolley  lines  which  are  profitable  only  as  parts  in  the  large  scheme 
of  the  whole.  From  now  on  almost  every  mile  of  trolley  develop- 
ment in  the  western  third  of  the  state  will  mean  the  opening  up 
of  territory  that  is  at  present  nearly  unproductive,  and  most  of  it, 
especially  in  the  Berkshire  section,  as  beautiful,  and  in  many  other 
respects  as  desirable  for  purposes  of  living,  as  one  could  wish. 

1011.  But  a  comparison  of  maps  does  not  show  what  has  been 
accomplished  by  unification  of  ownership  and  management  in  the 
hands  of  the  dominating  railroad  interest  to  lessen  distances,  to 
lessen  also  the  frequency  of  transfers,  to  regulate  the  schedules,  to 
improve  the  personnel  and  equipment,  and  in  every  other  respect  to 
raise  the  standard  of  trolley  service.  Interests  associated  with  the 
New  Haven  have  even  secured  a  certificate  of  public  necessity  from 
the  railroad  commissioners  to  construct  a  direct  high-speed  inter- 
urban electric,  more  of  the  Western  type,  between  Boston  and 
Providence. 

1012.  The  conclusion  seems  inevitable,  that  however  hostile  to 
this  New  Haven  policy  of  railway  "  saturation,"  with  its  implication 
of  monopoly,  the  people  of  Massachusetts  may  be,  due  in  large 
measure  to  the  fact  that  they  will  not  harden  themselves  to  the 
questionable  methods  iaat  are  thought  to  be  employed  in  attaining 
the  ultimate  result,  nevertheless  the  saturative  principle  represents 


STREET  RAILWAY  BONDS  327 

the  highest  development  in  transportation.  At  any  rate,  from  a 
transportation  standpoint,  considering  area,  density  of  population, 
and  geographical  configuration,  Massachusetts,  Connecticut,  and 
Rhode  Island  are  probably  as  well  served  as  any  other  territory  of 
like  size;  and  even  in  these  states  only  a  beginning  has  been  made 
in  the  saturative  policy  of  giving  a  community  all  the  transporta- 
tion service  its  population  and  commerce  will  bear. 

1013.  It  is  not  necessary  to  go  at  any  length  into  the  further 
attenuation  of  the  system  of  trunks  and  ramifications  which  makes 
for  saturation,  but  the  possibilities  in  this  age  of  electricity  are 
very  great.  The  next  step  perhaps  will  be  to  devise  a  car  that  may 
run  on  rails  or  leave  the  tracks  for  the  highwav  and  thus  make 
still  more  elastic  the  little  traffic  feelers  thrust  into  the  back 
country.  Colorado  seems  to  have  something  of  the  kind  for  mail 
delivery.  In  freight  service  we  shall  have  removable  trucks  that 
can  be  loaded  at  the  farmer's  barn,  taken  by  a  motor  "  rover,"  (to 
coin  a  word),  to  the  trolley  line,  and  thence,  if  for  a  long  haul,  can 
be  transferred  intact  to  the  freight  truck  of  the  steam  train.  Trol- 
ley cooperation  also  will  be  secured  in  the  terminal  transfer  of 
passengers  under  unit  of  management.  These  are  some  of  the  many 
gains  in  comfort,  economy,  and  convenience  that  we  owe  to  street 
railway  and  steam  cooperation. 

1014.  This  saturative  development  is  not  yet  to  the  exclusion 
of  competitive  development  in  the  East.  At  present  the  Buffalo, 
Lockport,  and  Rochester  is  trying  to  be  a  competitor  of  the  New 
York  Central  and  the  proposed  Buffalo,  Rochester,  and  Eastern,  if 
it  is  built,  may  be  a  real  competitor.  But  on  the  other  hand,  if  the 
Delaware  and  Hudson  has  been  actuated  by  any  definite  motive  in 
its  trolley  purchases,  it  must  have  had  before  it  the  New  England 
idea. 

1015.  Electrification  of  Steam  Roads.  Lastly  there  is  the  matter 
of  the  electrification  of  steam  roads.  For  years  small  stretches  of 
line  in  various  parts  of  the  country  have  been  operated  by  electricity. 
The  thought  with  all  it  implicates  has  been  common  railroad  prop- 
erty for  a  greater  length  of  time  than  most  people  imagine.  Even 
now,  by  city  ordinance,  the  New  York  Central  and  the  New  York,  New 
Haven,  and  Hartford  are  not  permitted  to  send  steam  locomotives 
for  regular  transportation  purposes  within  the  city  limits  of  New 
York.  The  Central,  and  the  New  Haven,  on  the  New  York  suburban 
divisions,  and  the  West  Shore,  for  suburban  traffic,  from  Utica  to 
Syracuse,  have  thoroughly  tried  out  electricity  as   motive  power 


32S  STREET  RAILWAY  BONDS 

with  results  that  are  satisfactory  except  under  very  abnormal 
weather  conditions — not  to  mention  what  has  been  done  by  the 
Illinois  Central,  the  Pennsylvania,  the  Long  Island,  the  Baltimore 
and  Ohio,  and  the  Burlington. 

1016.  Distinction  Between  Steam  and  Electric  Securities.  Who  shall 
say,  when  the  New  Haven  Road  shall  run  its  trains  from  New  York 
to  Boston  by  over-head  wire,  what  are  steam  railroad  securities  and 
what  trolley?  Under  which  head  shall  we  classify  the  obligations 
of  the  Lackawanna  and  Wyoming  Valley  Railroad,  which  has  been 
built  expressly  for  electrical  equipment,  both  passenger  and  freight, 
but  with  the  high  standard  of  present  steam  railroad  practice? 

1017.  If  the  general  run  of  trolley  bonds  is  not  good,  what  an 
injustice  to  class  with  them  the  third-rail  Aurora,  Elgin,  and  Chi- 
cago, with  its  heavy,  high-speed,  vestibule  express  service  across 
Illinois  and  over  the  Metropolitan  Elevated  into  the  heart  of  the 
business  district  of  Chicago ;  but  if  we  approve  the  third-rail  Aurora, 
Elgin,  and  Chicago,  must  we  stop  at  its  excellent  western  trolley 
feeder,  the  Rockford  and  Interurban? 

1018.  The  Investment  Principal:  Caveat  Emptor.  These  illustrate 
the  gradations  from  steam  railroads  and  their  securities  to  street 
railways  and  theirs. 

From  what  has  already  been  said  it  will  be  readily  acknowledged 
that  generalizations  are  of  little  avail  as  guides  to  street  railway 
bond  buying.  When  in  1903  the  Massachusetts  legislature  let  down 
the  bars  and  admitted  street  railway  securities  for  savings-bank 
investment  it  was  under  these  provisos : — that  the  bonds  should  be 
approved  by  the  Board  of  Savings-Bank  Commissioners,  that  the 
railway  should  be  incorporated  under  the  (stringent)  laws  of  the 
state,  that  it  should  be  located  wholly,  or  in  part,  therein,  and  have 
earned  and  paid  regular  dividends  on  all  its  outstanding  stock  of 
at  least  5  per  cent,  per  annum  for  the  five  years  preceding.  Some 
may  find  suggestions  here  to  guide  their  own  purchasing.  Yet  such 
are  the  vicissitudes  of  street  railroading  that  several  bond  issues, 
originally  approved,  have  become  illegal  holdings  for  the  Massachu- 
setts banks  during  the  intervening  years. 

1019.  Each  security,  therefore,  must  be  judged  individually,  on 
its  own  merits,  and  not  like  municipal,  equipment,  or  water  bonds, 
in  part  by  the  excellencies  of  its  class.  The  buyer  may  rest  mainly 
upon  the  judgment  of  his  bond  house  or  make  his  own  investigation. 
If  he  chooses  to  do  the  former,  he  is  likely  to  find  the  house  finan- 
cially interested  in  the  road,  and  although  this  tends  to  conservative 


STREET  RAILWAY  BONDS  329 

financing  it  prejudices  the  source  of  his  advice.  If  he  chooses  to  do 
Ihe  latter,  circumstances  are  once  more  against  him.  The  super- 
vision exercised  over  street  railway  companies  by  the  public  utility 
or  railroad  commissions  of  most  states  is  quite  perfunctory.  Only 
in  Vermont,  Massachusetts,  New  York,  and  Wisconsin  is  there 
thorough-going  oversight  and  control.  Few  companies  make  monthly 
reports  public.  New  York  State  requires  quarterly  returns  and 
Massachusetts,  Connecticut,  and  Pennsylvania  returns  once  a  year, 
but  most  states  make  no  publicity  requirement  at  all.  The  Com- 
merce Commission  is  less  exacting  with  interstate  electric  than  with 
interstate  steam  roads.  Hitherto,  perhaps  for  the  example  of  indus- 
trial corporations,  perhaps  from  the  internal  necessities  of  the  case, 
a  policy  of  reserve  has  usually  obtained,  but  that  is  gradually  be- 
coming a  thing  of  the  past. 

1020.  Secondly,  the  anatomy  of  a  street  railway  report  is  not  as 
revelatorv  of  true  conditions  as  that  of  a  steam  road.  The  svstems 
of  bookkeeping  have  not  been  unified  by  interstate  commission, — to 
the  great  detriment  of  sound  comparisons.1  The  mathematics  of 
street  railway  accounting  is  not  yet  the  developed  science  it  will 
become  under  stabler  conditions. 

1021.  Overcapitalization.  There  can  be  no  question,  too,  concern- 
ing the  gross  overcapitalization  of  the  industry.  Unfortunately 
the  latest  record  for  the  country  at  large  is  of  1907  and  therefore 
ancient  history.  The  following  tables  have  been  constructed  from 
the  report  of  the  Census  Bureau : 

Combined  Capitalization  of  Operating  and  Lessor  Companies 

1902  1907 

Funded  debt  outstanding $    992,709,139  f  1,677,063,240 

Capital  stock  outstanding 1,315,572,960  2,097,708,856 

Total  capital  liabilities 2,308,282,099  3,774,772,096 

Investments  other  than  street  rail- 
ways and  electric  light  plants. .        152,513,997  374,664,197 
Net    capital    liabilities    including 

electric  light  plants 2,155,768,102  3,400,107,899 

Miles  of  single  track  owned 22,389  33,834 

1  But  the  Street  Railway  Accountants'  Association  of  America  has  prescribed 
a  form  of  accounting  more  or  less  lived  up  to,  and  the  great  traction  holding 
companies  require  uniform  accounting  of  their  subsidiaries.  Wisconsin  re- 
quires uniform  accounting  of  electric  railways  in  the  state. 


330  STREET  RAILWAY  BONDS 

Net  capital  liabilities  per  mile  of 

single  track  owned $  96,287  $  100,495 

Funded   debt  per  mile   of  single 

track  owned 44,339  49,568 

1022.  Tbere  are  330  companies  that  generate  electricity  for  Bale 
for  light  and  power,  but  since  they  do  not,  as  a  rule,  maintain 
separate  plants  and  accounts  for  this  purpose,  it  is  impossible  to 
ascertain  what  proportion  of  the  net  capital  liabilities  should  be 
deducted  therefor.  Undoubtedly  it  is  a  small  part  of  the  whole,  for 
the  sale  of  electric  current  forms  only  4.|  per  cent,  of  the  gross 
earnings  of  these  companies.  From  various  figures  of  itemized  in- 
come, etc.,  from  118  of  the  companies  it  is  safe  to  say  that  the  electric 
railways  of  this  country  are  capitalized,  for  purposes  of  transporta- 
tion only,  at  about  195,000  per  mile,  and  of  this  $95,000  about 
$45,000  is  bonded  debt.  In  the  level  Ohio  country  where  conditions 
favor  economical  construction,  recent  capitalization  per  mile  of 
single  track  .was  $76,442,  of  which  $27,526  was  in  bonds  and  $48,916 
in  stock.  Massachusetts  lines  were  capitalized  at  $50,772.  The 
cost  of  construction  per  mile  varies,  perhaps,  from  $15,000  to  $100,- 
000  or  more.  In  the  opinion  of  engineers  the  average  may  be 
$45,000  for  good  city  properties  and  slightly  less  for  high  grade 
interurbans.  We  are  then  face  to  face  with  the  fact  that  the  average 
street  railway  bond,  at  best,  represents  no  more  than  the  original 
cost  of  ttye  physical  property. 

1023.  .■Without  taking  the  common  but  wholly  unjustifiable  stand, 
maintained  even  by  courts,  that  capitalization  should  represent  only 
expenditure,  or  at  least  replacement  value,  one  may  yet  pause  over 
the  significance  of  these  figures.  More  than  50  per  cent,  of  this 
trackage  had  been  built  during  the  preceding  five  years;  there  had 
been  little  time  for  any  great  increase  in  values  due  to  realty  im- 
provement or  even  to  franchise  revaluation  on  the  basis  of  increased 
earnings,  or  in  general  to  the  capitalizing  of  income.  What  is  worse, 
much  of  the  mileage  had  been  built  by  men  of  inexperience  in  trans- 
portation matters,  and  in  localities  badly  chosen.  But,  as  we  have 
seen,  the  trolley  is  a  wonderful  creator  of  transportation  business, 
and  it  is  by  this  item  of  new  business  and  by  skimping  maintenance 
and  depreciation  charges  while  the  roadbed  is  new,  that  many  com- 
panies have  been  able  to  postpone  the  day  of  reckoning  for  over- 
capitalization. No  doubt  this  skimping  policy  accounts,  in  part,  for 
the  change  from  the  low  operating  ratio  of  57.5  in  1902,  to  60.1  in 


STREET  RAILWAY  BONDS  381 

1907.  With  the  gradual  adjustment  to  evitable  expenditures  this 
ratio  will  probably  approach  that  of  steam  roads,  which  averages 
66  per  cent. 

1024.  The  condition  of  street  railroading  in  the  United  States  in 
1902  and  1907  as  reflected  in  dividend  and  interest  disbursements 
is  to  be  seen  from  the  following  analyses: 

Dividend  and  Interest  Disbursements  of  Operating  and  Lessor 

Companies  Combined 

1902  1907 

Dividend  paying  common  stock..      $560,326,121  $805,210,600 

Amount  paid  on  common  stock..       $28,737,887  $44,960,796 

Average  rate  per  cent,  for  paying 

companies 5.1  5.6 

Non-dividend      paying      common 

stock    $627,316,660  $971,709,476 

Per  cent,  of  all  common  stock  not 

paying  dividends 52  55 

Dividend  paying  preferred  stock.      $  83,869,055  $207,718,830 

Amount  paid  on  preferred  stock..      $    4,301,284  $    9,524,478 

Average  rate  per  cent,  for  pay- 
ing companies  5.1  4.6 

Non-dividend     paying     preferred 
stock $  42,936,124  $  44,061,124 

Per  cent,   of   all   preferred  stock 
not  paying  dividends 32  35 

Funded  debt  outstanding $992,709,139  $1,677,063,240 

Interest  paid  upon  it $  43,578,961  $     71,468,788 

Percentage    of    interest    disburse- 
ments to  total  debt 4.47  4.42 

Amount   of    funded    debt    in    de- 
fault   No  figures  given  No  figures  given 

1025.  An  industry  that  paid  nothing  on  35  per  cent,  of  its  pre- 
ferred  shares  and  on  55  per  cent,  of  its  common  shares  may  hardly 
be  said  to  have  been  in  superior  condition.1     As  to  the  disburse- 

1  Only  35.99  per  cent,  of  all  interstate  steam  railroad  capital  stock  was  non- 
dividend  paying  in   1909. 


/ 


332  STREET  RAILWAY  BONDS 

ments  for  interest  ii  is  impossible  to  obtain  satisfactory  statements 
from  which  to  estimate  what  proportion  of  the  funded  debt  was  in 
default.  Obviously  1.4  does  not  represent  what  was  due  on  the  total 
debt.  5.4  doubtless  would  be  a  closer  approximation  and  perhaps 
even  0.4  per  cent.  Of  799  companies  reporting  in  1902,  500  had  a 
total  surplus  for  dividends  of  $30,590,977,  and  233  had  total  deficits 
of  $3,755,707.  Although  all  companies  with  deficits  were  not  bonded, 
presumably  in  1902  between  10  and  15  per  cent,  of  the  street  rail- 
way obligations  in  the  United  States  were  in  default,  and  that  was 
a  year  of  great  prosperity.1  The  Census  Report  naively  says :  "  In 
preparing  the  income  account  and  balance  sheet  the  majority  of 
companies  charged  the  interest  on  funded  debt  as  paid."  (The 
italics  are  ours.)  In  1907,  072  companies  reported  a  total  surplus 
of  $51,201,981,  and  2G7  companies  total  deficits  of  $10,801,095. 

We  have  at  hand  recent  figures  for  certain  states.  Massachu- 
setts, which  has  been  ridiculed  in  many  quarters  for  the  stringency 
of  her  public  service  corporation  laws,  returned  only  30  companies 
out  of  85,  or  42  per  cent.,  that  wTere  in  a  position  to  pay  any  dividends 
at  all  during  the  year  ending  Sept.  30,  1907.  And  what  is  worse 
the  total  net  divisible  income  was  only  a  little  more  than  5£  per 
cent,  on  the  total  outstanding  stock.  In  New7  York  State  (omitting 
New  York  City),  only  11  per  cent,  of  the  companies  paid  dividends 
during  the  year  ending  June  30,  1907,  and  25  of  the  70  companies 
showed  a  deficit  after  payment  of  fixed  charges. 

1026.  Penny- Wise  Financing.  To  analyze  a  typical  income  account 
would  extend  this  paper  unduly,  but  speaking  categorically,  it  is  a 
commonplace  among  accountants,  that  upon  their  present  basis  of 
capitalization  and  earnings  it  is  not  possible  for  street  railways, 
as  a  whole,  to  make  adequate  charges  for  maintenance  and  de- 
preciation, to  deflect  a  sufficient  proportion  of  earnings  for  im- 
provement and  reserve,  and  yet  make  a  presentable  return  on  the 
ostensible  investment.  Some  or  all  of  these  items  will  be  slighted. 
The  readiest  temptation  is  to  economize  on  maintenance,  where  it 
will  be  least  noticed  for  a  time,  and  then  with  the  help  of  new 
business  to  make  good  the  unfinanced  depreciation  of  the  plant  and 
to  postpone  the  ultimate  reckoning  by  capitalizing  renewals  and 
replacements,  as  improvements  and  extensions,  and  later,  by  paying 
interest  on  the  new  burden,  from  new  business  again  to  continue 
the  process  of  usurious  restitution  ad  infinitum.     The  per  cent. 

1  Omitting  Income  "  Bonds,"  only  5.1  of  all  railroad  funded  debt  received  no 
interest  in  1909. 


STREET  RAILWAY  BONDS  333 

increase  of  miles  of  single  track  in  the  United  States  during  the 
great  construction  period,  from  1890  to  1902,  was  178.1,  and  yet 
during  the  same  period  the  increase  in  capital  stock  was  355.1  and 
of  funded  debt  424.7  and  (published)  cost  of  construction  and 
equipment  456.7.  The  explanation  of  the  discrepancy  between  the 
increase  in  mileage  and  the  other  items  is  to  be  found,  of  course, 
in  this  penny-wise  financing  under  the  burden  of  an  inflated  capitali- 
zation. 

1027.  It  is  the  well-known  policy  of  American  steam  railroads 
(as  contrasted  with  English,  for  instance)  to  pay  for  even  extraor- 
dinary betterments  and  extensions,  in  part  at  least,  out  of  earn- 
ings. Because  of  this  policy  a  great  injustice  is  done  our  railroads 
in  charging  them  in  this  generation  with  stock  watering.  But  if 
there  is  any  justice  in  the  reproach  it  is  when  used  of  the  trolleys. 
Even  now  this  procrastinatory  financing  is  coming  into  its  own; 
street  railway  receiverships  are  common  in  the  land,  and  doubtless 
there  are,  at  present,  more  issues  of  street  railway  bonds  in  default 
than  of  any  other  class  of  securities  dealt  with  in  this  book. 

1028.  The  Franchise:  Its  Life.  But  to  turn  to  investment  prob- 
lems,—jjie_Jirj3t_j?onshIerj^ 

ties  is  the  franchise.  A  steam  railroad's  right  of  way,  once  obtained, 
is  its  possession  for  all  time;  but  the  trolley,  by  invading  the 
principal  streets  and  highways,  in  most  cases  must  accept  its  privi- 
leges as  temporary,  and  must  plan,  finance,  construct,  and  operate 
with  the  possibility  of  losing,  in  time,  some  portion  of  the  results 
of  its  labors.1  Sufficient  pressure  even  may  be  brought  to  bear  to 
curtail  the  charter  life  granted  it  by  legislation.  In  any  case,  it  is 
highly  undesirable  that  a  bond  issue  should  mature  at  or  very  near 
the  expiration  of  the  franchise,  yet  a  very  large  number  do.  The  Chi- 
cago City  Railway  illustrates  both  points.  Its  charter,  granted  by 
the  legislature,  was  to  expire  in  1958,  but  by  reason  of  recent  un- 
settled traction  conditions  in  Chicago,  it  seemed  to  the  company 
advisable  to  waive  this  right  and  accept  the  terms  of  a  city  ordi- 
nance granting  a  20-year  conditional  franchise.  Owing  to  the 
conditions  surrounding  the  grant  of  the  franchise  the  new  first 
mortgage  bonds  of  the  company  expire  the  same  year  as  the  fran- 
chise. 

1029.  It  is,  of  course,  even  more  undesirable  to  have  the  bonds 

1  This  would  not  apply  to  the  Tampa  Electric  Company  with  its  999-year 
franchise  nor  to  the  many  companies  with  unlimited  charter  life,  if  the 
validity  of  these  franchises  can  be  maintained  successfully. 


3t 


334  STREET  RAILWAY  BONDS 

mature  after  the  expiration  of  the  franchise.  This  actually  happens 
in  some  cases.  A  variation  of  this  mischance,  likely  to  be  overlooked, 
is  iu  the  case  of  the  bonds  of  a  holding  company  that  is  largely  de- 
pendent on  its  subsidiaries  for  revenue.  Sometimes  the  franchises 
of  one  or  more  of  the  subsidiaries  expire  before  the  maturity  of  the 
holding  company  bonds.  In  this  event  the  degree  of  loss  in  security 
sustained  by  the  bonds  in  question  can  be  theoretically  prefigured 
by  calculating  the  ratio  of  earning  power  lost  to  the  company  by 
cessation  of  income  from  this  source,  should  the  particular  sub- 
sidiary franchise  not  be  renewed.  If  the  date  of  its  expiration  is 
at  some  remove,  it  is  possible  that  the  amortization  of  the  holding 
company  bonds  would  lessen  the  interest  charges  to  such  degree  that 
even  with  the  loss  of  subsidiary  revenue  the  margin  of  safety  due 
to  income  would  be  proportionately  as  great  as  ever.  For  those 
who  wish  to  work  out  this  problem  the  Paducah  Light  and  Traction 
Company  is  offered  in  illustration.  The  First  Mortgage  Collateral 
Trust  5s  expire  in  1935.  There  is  a  sinking  fund  of  one  per  cent, 
per  annum  upon  bonds  issued,  waivable  until  1911.  The  railway 
and  electric  lighting  franchises  expire  in  1924 ;  the  gas  fran- 
chise is  perpetual.  Obviously  this  company  is  working  at  great 
disadvantage. 

1030.  One  of  the  difficulties  now  faced  by  the  United  Railways 
of  St.  Louis  is  the  expiration  of  the  franchises  of  some  of  its  sub- 
sidiaries. The  company  maintains  that  the  grant  of  its  own  fran- 
chise (expiring  in  1948),  in  the  nature  of  the  case,  extends  the 
franchises  of  its  divisions.  Unfortunately  (from  a  legal  viewpoint), 
the  city  will  probably  waive  its  claims  in  favor  of  a  general  scheme 
of  compromise,  involving  other  considerations,  and  the  matter  will 
not  be  threshed  out  in  the  courts. 

1031.  Interurban  electric  roads  often  run,  like  railroads,  largely 
upon  their  own  right-of-way,  except  at  crossings  and  through 
streets,  so  that,  with  such  companies,  the  franchise  matter  is  of 
less  moment. 

1032.  The  Franchise:  Its  Character.  Second  for  consideration  to 
the  life  of  the  franchise  is  its^^kaxatijiE,  Bond  circulars  seldom  are 
sufficiently  explicit  as  to  the  scope  and  import  of  its  terms.  Is  it 
exclusive?  Does  it  impose  conditions  or  tribute,  (e.g.  an  unjust 
excise  tax),  that  work  hardship  to  the  grantee?  Does  the  city  or  the 
state  reserve  the  right  to  amend  it?  What  are  its  terms  as  to  trans- 
fers and  tariffs?  The  Chicago  company  just  mentioned  and  the 
Interborough  Rapid  Transit  Company  of  New  York  are  expressly 


STREET  RAILWAY  BONDS  335 

permitted,   with   proper   reservations,   to   charge   a   five-cent   fare. 
Other  questions  of  like  tenor  will  suggest  themselves  to  the  buyer. 

1033.  This  five-cent  fare,  the  fixed  unit  of  price,  especially  in 
cities,  for  the  commodity  street  railways  have  for  sale,  namely 
transportation,  is  an  economic  error  that  we  will  do  well  to  rid  our- 
selves of.  Custom,  charter  restrictions,  legislative  enactment,  and 
the  very  denominations  of  our  currency  help  to  maintain  an  inad- 
justable  relation  between  cost  and  selling  price  that  has  worked 
much  greater  hardship  for  street  than  for  steam  roads.  Many 
European  cities,  with  more  favorable  currency  denominations,  and 
even  Canadian  cities,  such  as  Toronto  and  Montreal,  with  currency 
like  our  own,  have  well-thought-out  systems  of  transportation  charge 
wherein  some  attempt  is  made  to  regulate  price  according  to  service 
rendered.  It  is  to  be  noted  with  approval,  as  a  break  with  tradition, 
that  in  Massachusetts  the  Railway  Commission  has  recently  author- 
ized certain  impoverished  street  railway  companies  to  raise  their 
unit  of  fare  for  the  time  being  to  six  cents. 

1034.  It  is  customary  to  consider  the  railway  franchise  as  part 
of  the  security,  with  "  property,  rights,  etc.,"  behind  the  first  or  gen- 
eral mortgage  bonds.  If  this  assertion  is  put  forward  of  any  issue 
it  will  bear  looking  into.  PnhliY  sprvirp  corporations  cannot  trans- 
fer their  franchises  by  mortgage  assignment  without  legislative 
authority,  which,  however,  is  quite  freely  given.  Many  cities  have 
passed  ordinances  specifically  forbidding  the  assignment  of  street 
railway  franchises.  This  does  not  prevent  the  making  of  mortgages 
in  ordinary  course,  under  general  statutory  authority,  secured  upon 
trackage  and  equipment,  but  in  foreclosure  the  new  owners  will 
have  to  take  their  chances  of  obtaining  municipal  consent  to  the 
operation  of  the  road. 

1035.  Importance  of  Amortization.  Third,  unless  the  charter  life 
is  without  limit,  it  is  extremely  important  that  ample  provision 
made  for  the  redemption  of  a  large  part  of  the  issue  by  maturity, 
either  through  a  sinking  fund  or  through  the  annual  recall  of  a 
percentage  of  the  bonds.  One  is  likely  to  overlook  this  matter, 
since  it  is  such  an  unimportant  aspect  of  steam  road  financing. 
Practically,  it  is  of  little  general  consequence  whether  a  railroad 
bond  ever  matures — there  are  not  a  few  that  run  well  into  the  21st 
century — for  the  corporate  life  of  the  railroad  is  everlasting  and 
the  demand  for  its  activities  undoubtedly  permanent;  but  a  trolley 
company,  with  an  unrenewable  franchise  on  its  hands,  is  virtually 
dead;  and  the  dead  pay  no  debts. 


be  \ 


336  STREET  RAILWAY  BONDS 

1036.  Importance  of  Territory  Served.  Fourth,  let  the  buyer  of 
electric  railway  bonds  investigate  most  carefully  the  territory  served. 
Other  things  being  equal,  a  growing  town  or  city  serves  his  pur- 
pose  best.  With  increase  of  population,  wealth,  and  traffic  will 
come  a  sure  increase  in  the  value  of  his  security.  His  bonds  will 
strengthen  and  profit  by  the  further  development  of  the  country 
just  as  surely  as  did  the  early  railroad  bonds, — the  6  and  7  per  cent, 
railroad  bonds  put  out  in  the  sixties.1 

1037.  If  the  road  is  an  interurban,  let  him  be  certain  that  it  can 
offer  real  advantages  in  economy,  speed,  or  comfort  of  travel  as 
compared  with  competing  steam  roads  if  there  are  any,  and  that  a 
prosperous  rural  or  suburban  community,  with  traffic  possibilities, 
awaits  proper  development.  This  may  seem  trite,  but  there  are  to 
be  found  millions  of  dollars  in  street  railway  bonds  that  lack  these 
assurances.  Sectional  distinctions,  relative  to  soundness  in  street 
railway  investment,  cannot  be  drawn. 

1038.  Apart  from  the  four  special  considerations  mentioned,  the 
bond  buyer  will,  of  course,  take  into  account,  as  in  the  case  of  any 
corporation  security,  the  character  of  the  management,  the  earning 
power,  the  dividend  record,  and  the  future  prospects.  In  particular 
he  will  analyze  most  carefully  the  income  account.  Another  ex- 
tremely helpful  exercise  for  just  discrimination, — and  this  will 
apply,  although  in  less  degree,  to  other  classes  of  bonds, — is  to  be- 
come thoroughly  familiar  with  some  one  company  acknowledged  by 
common  consent  to  be  entirely  sound  and  flourishing,  and  with  this 
as  touchstone  to  test  others.  The  Aurora,  Elgin,  and  Chicago  is 
suggested  as  such. 

1039.  Investment  Characteristics.  Finally,  lest  the  picture  be 
painted  too  darkly,  let  the  investor  not  turn  away  because  of  the 
failings  of  the  street  railway  class:  let  him  remember  that  there  are 
numbers  of  splendidly-equipped  and  well-operated  companies,  with 
records  and  capacity  for  earning  beyond  question, — the  mortgage 
bonds  of  which,  selling  upon  a  basis  of  over  one  per  cent,  higher 
income  yield  than  those  of  steam  roads  of  the  same  character,  have 
the  advantage,  in  common  with  railroad  bonds,  of  a  readier  market 
than  many  other  securities  of  the  same  yield.  An  Ohio  bond  house 
that  specializes  in  street  railway  securities  of  the  Lake  states  offered, 

1  For  a  more  detailed  discussion  of,  and  a  more  favorable  attitude  toward 
Interurbans,  see  "  Electric  Interurban  Railway  Bonds  as  Investments,"  by  Edgar 
Van  Deusen,  in  Bonds  as  Investment  Securities,  American  Academy  of  Political 
and  Social  Science,  Philadelphia,  1907. 


STREET  RAILWAY  BONDS  337 

in  the  summer  of  1908,  the  first  mortgage  bonds  of  eleven  companies 
in  good  standing,  at  an  average  income  yield  of  almost  six  per  cent. 
The  average  life  of  the  bonds  was  nine  years.  One  cannot  do  as 
well  as  that  in  the  short  time  first  mortgage  bonds  of  Eastern  street 
railways  of  the  same  grade. 

1040.  These,  then,  are  the  characteristics  of  street  railway  bonds : 
relatively  poor  security  as  a  class,  high  yield  upon  the  investment, 
and,  considering  the  yield,  a  responsive  market.  Men  of  affairs, 
capable  of  diagnosing  reports,  who  require  a  large  return  and  yet 
a  form  of  investment  that  is  fairly  convertible,  find  their  needs  met 
with  well-selected  street  railway  bonds. 


CHAPTER  XXVI 
GAS  COMPANY  BONDS 

1041.  Importance  of  the  Gas  Industry.  In  the  United  States 
Census  reports  of  1905,  the  manufacture  of  gas  ranked  second  in 
capitalization  among  all  the  industries  recorded.  Only  for  foundry 
and  machine  shop  products  was  more  money  devoted.  There  were 
1019  gas  establishments  with  a  total  capital  of  about  $725,000,000. 
This  will  serve  roughly  to  show  the  importance  of  gas  manufacture 
in  America. 

1042.  The  Competition  of  Oil  and  Electricity.  But  gas  is  a  staple 
in  more  senses  than  one.  It  has  been  in  common  use  in  our  cities 
as  an  illuminant  for  nearly  a  hundred  years.  It  has  grown  with 
the  growth  of  population  and  in  greater  degree.  For  instance,  from 
1890  to  1900  the  increase  in  the  product,  for  all  purposes,  was  33 
per  cent.;  the  increase  in  population  21  per  cent.  It  has  always 
had  nominal  competition  from  other  kinds  of  lighting.  In  the 
earlier  days  candles  and  oil  lamps  were  the  recourse  of  those  who 
found  gas  not  feasible  or  too  dear.  These  modes  of  lighting  bore 
a  similar  relation  to  gas  that  gas  does  now  to  electricity.  It  must 
be  borne  in  mind  that  gas  then  was  a  luxury  and  had  to  be  paid 
for  as  such.  It  was  expensive  to  manufacture.  One  ton  of  anthra- 
cite coal  of  good  quality  would  produce  only  10,000  cubic  feet  of 
gas,  for  gas  was  simply  the  vapor  distilled  from  coal  under  subjec- 
tion to  heat.  The  residue  was  discarded  as  worthless.  It  was  a 
luxury  also  in  the  sense  that  it  gave  a  vastly  more  convenient  and 
superior  light.  To  lessen  the  advantage  oil  lamp  manufacture  was 
revolutionized  and  ultimately  brought  to  the  state  of  comparative 
perfection  attained  in  the  present  central-draft  burners.  But  the 
development  of  the  lamp,  with  its  quadrupled  efficiency,  has  been  no 
hindrance  to  the  gas  industry ;  quite  the  contrary.  It  educated 
people  to  the  freer  use  of  light,  not  only  in  the  assembly  hall  and 
street,  where  oil  lamps  were  really  inadequate,  but  in  the  home, 
the  proper  field  for  them.    Both  kinds  of  light  profited. 

338 


GAS  COMPANY  BONDS  339 

1043.  However,  one  no  longer  thinks  of  the  oil  lamp  as  the 
natural  competitor  of  gas,  but  rather  electricity ;  and  the  intending 
investor  in  gas  securities  may  hesitate  upon  this  very  point.  He 
need  have  no  concern.  Electricity  is  now  the  luxury  and  gas  the 
staple,  and  economic  history  is,  in  part,  repeating  itself.  Electricity, 
particularly  for  mercantile  and  public  purposes,  is  educating  the 
people  to  still  freer  use  of  light,  and  gas  is  profiting  thereby.  As 
gas,  the  newer  mode  of  lighting,  improved  lamps,  so  electricity, 
the  still  newer  mode,  has  improved  gas  light.  The  exacting  re- 
quirements of  a  photometry  that  knew  the  arc  light  produced  the 
Welsbach  mantle,  and  the  Welsbach  mantle  is  in  process  of  univer- 
salizing the  application  of  incandescence  to  gas  lighting. 

1044.  Observe  this,  too,  in  favor  of  gas  lighting,  that  the  limit  1 
of  its  capacity  for  improvement  is  not  yet,  and  with  the  high- 
pressure  intensified  lighting  system  it  is  an  open  question  whether 
it  is  not  even  supplanting  its  younger  rival,  electricity,  in  some  of  the 
very  fields  from  which  it  was  only  recently  ousted.  This  is  not  a  brief  , 
for  gas  as  against  electricity.  There  are  a  remarkable  number  and 
variety  of  functions  that  electricity  is  being  called  upon  to  perform, 
as  light  and  heat  and  power ;  but  these  functions,  for  the  most  part, 
do  not  trespass  upon  the  functions  of  gas  so  much  as  they  supplement 
them;  they  are  rather  the  creations  of  a  new  standard  of  luxury 
which  has  been  raised  by  knowledge  of  the  latent  capabilities  of 
this  new  force.  Therefore  it  is  not  an  invidious  comparison  to  state 
that  London,  Liverpool,  Paris,  and  Berlin  are  now  burning  more 
gas  than  electricity  for  municipal  lighting,  and  that  Glasgow, 
five  years  or  so  ago,  decided  to  employ  thereafter  only  incandescent 
gas  lighting  for  streets  not  then  electrically  illuminated.  The 
tendency  in  our  own  cities  is  the  same. 

1045.  The  causes  for  this  reversion  to  the  older  mode  are  several, 
and,  of  course,  different  in  different  cases.  The  one  that  comes 
first  to  mind  is  the  improvement  attained  in  the  quality  of  light  pro- 
duced from  gas,  due  to  better  gas,  better  burners,  and  better  methods 
of  reflection.  But  the  matter  of  cost  is  all-important.  Three- 
quarters  of  the  illuminating  gas  now  made  in  this  country  is  water 
gas, — that  is,  gas  produced  by  the  contact  of  steam  upon  hot  coals 
and  then  enriched  by  cannel  coal,  naphtha,  or  petroleum  vapor. 
Among  large  companies  the  gross  cost  of  manufacture  (including 
wages)  by  this  process  runs  from  25  cents  to  $1.00,  depending  largely 
upon  the  price  of  coal.  The  average  for  the  largest  sixteen  companies 
in  Massachusetts  is  53  cents,  but  this  is  very  high.    Of  this  amount 


340  GAS  COMPANY  BONDS 

9  cents,  or  17  per  cent.,  represents  the  cost  of  the  enrichers  used  to 
bring  the  gas  up  to  the  required  standard  of  quality.  It  may  be 
mentioned  here,  parenthetically,  that  incandescent  gas  lighting 
will  dispense  with  the  necessity  of  costly  enriching  agents,  because 
light  value  in  gas  will  no  longer  be  the  desideratum,  but  heat  value. 
It  is  this  present  and  prospective  lowering  of  cost  with  improved 
quality  and  candle  power  and  more  economical  combustion  which 
electricity  finds  hard  to  combat.  It  does  not  now  pay  to  sell 
electricity  to  the  small  consumer  for  a  use  of  less  than  three  hours 
per  day.  In  view,  therefore,  of  the  facts  presented,  it  is  not  sur- 
prising that  men  engaged  in  the  conduct  of  both  businesses  aver  that 
the  use  of  electricity  is  no  deterrent  to  the  growth  in  consumption 
of  gas. 

1046.  A  tabulation  for  the  years  1893,  1899,  and  1902,  of  61 
prominent  cities  in  the  United  States,  all  of  which,  of  course,  were 
supplied  with  electricity,  shows  the  following  results: 

1893  1899  1902 
Total  gas  output 

in  cubic  feet..  24,547,888,450  34,098,912,029  47,661,899,700 

Increase  9,551,023,579  13,562,987,671 

Increase  per  cent.  39$  in  6  yrs.  31$  in  3  yrs. 

There  are  too  many  factors  entering  into  the  composition  of  any 
such  set  of  figures  to  make  it  satisfactory;  but  this  much  may  be 
said : — as  long  as  the  consumption  of  gas  increases  at  the  rate  of  10 
per  cent,  a  year  in  cities  with  well  established  sources  of  electrical 
supply  the  competition  so  set  up  is  negligible,  whether  the  increase 
in  consumption  of  gas  is  due  to  freer  use,  decrease  in  cost,  growth 
in  population,  or  all  combined. 

1047.  Economic  Development.  We  have  considered  gas  hitherto 
chiefly  as  an  illuminant.  We  have  observed  the  age  and  importance 
of  the  industry,  its  growth  under  stress  of  competition,  and  some 
causes  for  its  successful  issue  therefrom.  Other  aspects  remain  which 
show  additional  causes  for  its  present  commercial  well-being.  Chief 
among  these  is  the  comparatively  recent  utilization  of  gas  for  pur- 
poses of  power  and  heat  (fuel  gas),  especially  in  those  sections  of 
the  country  where  there  is  no  bituminous  or  semi-bituminous  coal. 

1048.  Fuel  Gas.  It  is  the  only  source  of  power  for  commercial 
purposes  which  can  be  used  anywhere  and  everywhere  without  the 
aid  of  steam  auxiliaries.    On  the  other  hand,  it  can  generate  all  the 


GAS  COMPANY  BONDS  341 

other  kinds  of  commercial  power,  viz.,  steam,  electricity,  and  com- 
pressed air.1  It  will  develop  more  light,  heat,  and  dowpi-  to  the  ton 
of  coal  than  that  snniP!  coal  can  generate  under  boilers.  It  is  the 
form  of  power  most  easily  stored.     It  is  smokeless. 

1049.  With  these  facts  in  mind  and  with  the  knowledge  that 
gas  engine  building  has  kept  pace  with  the  general  development  of 
machinery  building,  we  are  prepared  to  learn  that  during  the  decade 
1890-1900,  the  output  of  steam  engines  in  the  United  States  increased 
90  per  cent,  and  of  gas  and  vapor-combustion  engines  over  1500 
per  cent.2  But  gas  engines  were  infant  prodigies  in  1890.  It  is 
more  to  the  point  that  in  1903,  of  the  45  companies  in  Ohio  reporting 
an  estimated  consumption  of  gas  for  fuel  equal  to  2  per  cent,  of  their 
total  gas  consumption,  an  average  has  been  struck  indicating  that 
approximately  one-third  of  all  the  gas  manufactured  in  that  state 
from  coal  was  used  for  fuel.  This  figure  is  put  forward  with  caution 
as  the  best  obtainable  from  the  companies'  own  reports,  but  the 
reports  are  merely  managers'  estimates  and  by  no  means  exact. 
However,  accurate  or  not,  it  suffices  to  show  that  the  future  of  gas 
is  not  wholly  dependent  upon  lighting.  Fuel  gas  and  gas  used  for 
fuel  are  not  necessarily  the  same.  Cooking  now  consumes  the 
larger  part  of  gas  used  for  fuel  and  may,  in  time,  require  a  larger 
output  of  gas  than  lighting  itself. 

1050.  The  Residuals.  Another  source  of  income  is  the  utilization 
of  by-products.  Coke,  coal-tar,  and  ammonia  acids  are  now  ob- 
tained from  what  was  formerly  mere  waste.  There  are  no  means 
by  which  to  ascertain  what  proportion  of  gross  earnings  is  due  to 
the  sale  of  residuals — for  the  country  at  large, — but  for  the  year 
1906  the  16  gas  companies  of  Massachusetts  mentioned  before,  re- 
port income  derived  from  residuals  as  over  5-|  per  cent,  of  the  total ; 
or,  put  in  another  way,  40  Massachusetts  companies  receive  from  the 
sale  of  their  residuals,  an  average  of  39  per  cent,  of  the  cost  of  their 
coal.  This  should  be  remembered  in  connection  with  the  steady 
decline  in  gas-prices  for  the  past  25  years  and  its  effect  upon  the 
industry. 

1051.  In  view,  therefore,  of  the  economic  position  of  the  gas 
industry,  its  continued  growth,  and  the  variety  of  activities  that 
are  dependent  upon  its  service,  it  should  not  be  surprising  that 
companies  operating  under  proper  and  normal  conditions  are  con- 

1  Gasoline,  liquid  air,  etc.,  as  commercial  agents,  are  of  the  future  rather  than 
of   the   present. 

2  The  automobile  came  into  common  use  only  toward  the  close  of  the  decade. 


342  GAS  COMPANY  BONDS 

Bistent  and  generous  revenue  earners.    Now  as  to  what  constitutes 
proper  and  normal  conditions. 

1052.  The  annual  reports  of  the  Massachusetts  Board  of  Gas  and 
Electric  Light  Commissioners  are  the  most  studied  and  detailed  that 
are  issued  regarding  the  principal  two  lighting  industries.  Any 
one  at  all  concerned  is  obliged,  sooner  or  later,  to  resort  to  them 
for  reference;  they  are  invaluable.  It  is  because  of  their  fullness 
that  the  figures  for  Massachusetts  are  used  so  extensively  in  this 
discussion.  An  analysis  of  the  twenty-fifth  report,  covering  the 
fiscal  year  1908-09,  will  help  to  an  understanding  of  what  are 
the  conditions  favorable  to  successful  gas-manufacture. 
~~~7>  ^  1053.  The  Elements  of  Successful  Operation.  Of  the  75  companies 
operating  in  the  state  during  the  year,  five  only  did  not  pay  ex- 
penses, but  21  others  did  not  earn  "  sufficient  to  warrant  the 
declaration  of  any  dividend."  This  does  not  seem  a  particularly 
favorable  statement,  but  closer  examination  alters  the  case.  Of 
the  49  dividend-payers  only  five  pay  dividends  of  5  per  cent,  or  less; 
12  pay  dividends  of  12  per  cent,  or  more;  one  pays  30  per  cent.; 
another  31  per  cent.,  and  the  average  dividend  for  the  paying 
companies  is  10.2  per  cent.  This  suggests  that  gas-companies,  in 
Massachusetts  at  least,  are  either  very  good  or  very  bad.  The 
main  reason  for  the  bad  is  not  far  to  seek.  It  is  briefly  put  in 
the  following  table: 

Non-Dividend  Paying  Companies   (1906)  in  Massachusetts 

Number  of  Assessed  Value  Population 

Stockholders  of  Property  Served 

Maximum    74  $438,200  37,830 

Minimum 3  $250  500  ( Est.) 

Average   12  $47,866  7,717 

1054.  Importance  of  Size  and  Population  Served.  The  most  notable 
feature  of  this  exhibit  is  the  diminutive  size  of  the  unprofitable 
companies.  Five  of  them  are  not  even  incorporated.  The  largest 
in  this  class,  serving  a  population  of  38,000,  is  the  Haverhill  Gas 
Light  Company,  which,  until  recently,  was  a  large  dividend  payer, 
but  as  the  result  of  some  attempted  financing  by  questionable 
methods  has  been  temporarily  under  a  cloud.  The  second  largest, 
the  Citizens  Company  of  Quincy,  supplies  a  population  of  only 
28,000.     The  rest  are  in  small  towns,  summer  resorts,  etc.,  where 


GAS  COMPANY  BONDS  343 

they  exist,  presumably  like  rural  telephone  lines,  more  for  the 
convenience  of  the  citizens  than  for  money-making  purposes.  The 
average  number  of  stockholders  bears  this  out. 

1055.  The  Relation  of  Rates  to  Population.  Manifestly,  gas  is  a 
commodity  that  cannot  be  manufactured,  distributed,  and  sold  to 
advantage  on  a  small  scale.  The  rates  charged  by  these  weaker 
companies  show  this.  Omitting  from  the  table  above  those  selling 
acetylene,  the  average  gross  price  per  thousand  cubic  feet  is  $2.40. 
But  the  average  selling  price  of  the  16  largest  companies  in  Massa- 
chusetts, (all  of  which,  with  the  exception  of  the  Haverhill  Gas 
Light  Company,  are  good  dividend  payers),  is  only  $1.16,  or  less 
than  half. 

1056.  The  Relation  of  Output  to  Population.  Further  analysis 
along  the  same  lines  but  involving  the  figures  for  population  in  its 
relation  to  gas  output,  leads  to  the  conclusion  that  in  Massachu- 
setts the  consumption  of  gas  in  cities  of  75,000  or  less  tends  to  vary 
inversely  as  the  price,  but  in  larger  cities  (as  we  found  for  the 
whole  country  in  the  decade  1890-1900)  the  consumption  tends  to 
increase  in  greater  ratio  than  the  population.  A  large  population 
served  usually  indicates,  of  course,  a  company  operating  in  a  large 
city,  for,  unlike  electricity,  gas  is  very  strictly  limited  in  dis- 
tributable area  by  both  mechanical  and  commercial  considerations. 
In  cities  of  this  population,  implying  the  presence  of  extensive 
manufacturing  and  contiguity  of  buildings,  especially  those  having 
many  stories,  there  is  felt  the  economy  of  concentration  which 
lessens  the  cost  of  installation  and  maintenance,  and  increases  the 
proportion  of  population  served  and  therefore  the  per  capita  con- 
sumption. Under  anything  like  the  present  conditions  of  heating 
and  lighting  we  are  then  to  expect  that  large  and  well  established 
gas  companies  in  cities  of,  let  us  say,  over  75,000  population  will 
increase  their  sales  annually  without  interruption  so  long  as  the 
population  they  serve  increases.  It  is  as  certain  as  the  increase  in 
freight  tonnage  and  passenger  traffic  upon  a  trunk  line,  over  a  long 
period  of  years,  and  it  is  a  great  deal  steadier. 

1057.  Still  there  are  those  who  feel  that  lighting,  especially  as  a 
science,  is  to  see  great  changes  in  the  near  future, — changes  that 
may  unsettle  the  status  of  gas  securities.  It  is  not  likely  that  the 
gas  business  will  ever  meet  more  radical  changes  than  those  it  has 
already  faced  in  the  coming  of  electricity;  but  if  so  the  result  will 
certainly  be  the  absorption  of  the  younger  industry  or  the  creation 
of  a  new  set  of  wants  for  it  to  supply.    This  is  the  present  phase  of 


344  GAS  COMPANY  BONDS 

the  competition  of  electricity  and  steam  in  transportation.  Tn 
some  sections  it  is  being  solved  in  the  one  way;  in  other  sections  in 
the  other.  Just  as  we  find  many  gas  and  electric  companies 
coalescing,  the  electric  company  being  taken  over  by  the  older  con- 
cern, to  facilitate  interchange  of  business,  and  to  unify  and  econo- 
mize management,  so  in  New  England  the  railroads  have  taken  over 
the  trolley  systems  and  will  eventually  reap  the  benefit  of  their 
operation.  Just  as  in  other  cities,  the  independent  electric  com- 
panies, finding  themselves  unable  to  serve  the  small  consumer  for 
lighting,  in  competition  with  gas,  are  devising  ingenious  labor- 
saving  contrivances  to  broaden  the  demand  for  their  current,  so  in 
the  Lake  region,  the  interurban  trolley  systems,  working  inde- 
pendently of  the  railroads,  are  creating  a  new  kind  of  short  haul 
freight  and  passenger  traffic,  which,  by  not  cutting  into  the  revenues 
of  the  railroads,  is  solving  the  problem  of  a  competition  that  at 
one  time  looked  serious. 

1058.  It  should  be  understood,  therefore,  that  the  thing  to 
emphasize,  in  purchasing  gas  securities,  is  not  the  question  of  com- 
petition, but  the  size  of  the  company.  With  few  other  kinds  of 
securities,  except  those  of  electric  light  companies,  does  the  matter 
of  size  have  so  important  a  bearing  on  safety. 

1059.  The  Decline  in  Rates.  The  future  of  gas  prices  is  another 
matter  of  concern  with  some.  Realizing  the  great  reductions  that 
are  now  being  made,  voluntarily,  and  by  direction  of  legislatures  and 
state  commissions,  people  are  inclined  to  be  fearful  that  this  in- 
dustry will  suffer  at  the  hands  of  politicians  and  others  to  the  extent 
perhaps  of  eating  into  reasonable  profits.  The  publicity  given  to  the 
difficulties  of  companies  in  our  largest  cities,  notably  New  York, 
Boston,  and  Chicago,  lends  color  to  the  objection. 

1060.  But  whatever  may  be  the  present  impulses  to  these  reduc- 
tions, the  process  of  price-scaling  is  nothing  new.  From  a  careful 
survey  of  the  rates  of  172  companies  in  the  principal  cities  of 
the  United  States,  extending  back  over  a  period  of  23  years,  it  is 
possible  to  state,  with  authority,  that  there  is  no  present  marked 
acceleration  to  the  decline  in  prices.  Rather,  that  the  scaling  has 
been  fairly  constant  for  the  period  except  in  such  companies  as  had 
suddenly  to  meet  the  competition  of  natural  gas.  The  average  price 
for  these  172  companies  in  1885  was  $2.01;  11  years  later,  189G, 
it  was  $1.53,  a  loss  of  48  cents;  and  11  years  after  that,  1907,  it 
was  $1.09,  a  further  loss  of  44  cents.    So  it  will  be  seen  that  the 


GAS  COMPANY  BONDS  345 

decline  was  somewhat  greater  for  the  earlier  period  than  for  the 
later,  but  fairly  constant  as  respects  the  periods.1 

1061.  The  Relation  of  Rates  to  Profits.  There  are  64  companies 
in  cities  with  a  population  of  25,000  or  more  selling  gas  at  $1.00, 
seven  at  95  cents,  19  at  90  cents,  14  at  85  cents,  18  at  80  cents,  13 
at  75  cents,  five  at  70  cents,  one  at  65  cents,  six  at  00  cents,  and 
three,  under  exceptional  conditions,  at  50  cents.2  Some  of  these 
companies  are  among  the  best ;  the  large  majority  are  on  a  regular 
dividend-paying  basis.  The  Milwaukee  Gas  Company,  one  of  the 
strongest  in  the  country,  with  a  perpetual  monopoly  of  the  business 
in  its  city,  and  a  record  of  uninterrupted  dividends  for  the  past 
47  years,  sells  gas  for  fuel  and  lighting  at  60,  70,  and  80  cents  for 
the  first,  second,  and  third  or  more  thousand  feet,  respectively. 
The  Lynn  (Mass.)  Gas  and  Electric  Company,  paying  30  per  cent, 
dividends  in  1907,  and  12  per  cent,  in  1908  and  1909,  sells  gas  for  all 
purposes  and  in  any  amounts  at  85  cents  net,  and  the  Boston 
Consolidated  Gas  Company  also. 

1062.  The  conclusion  is  that  the  decline  in  prices  is  due  to  lowered 
costs  made  possible  by  more  economical  processes  of  manufacture, 
better  business  methods,  a  market  for  the  by-products,  and  greater 
total  and  per  capita  consumption. 

1063.  It  is  quite  possible  that  we  have  not  yet  reached  bed-rock  in 
the  matter  of  rates.  Indeed  when  manufacturing  cost  is  so  low  as 
to  permit  the  Massachusetts  Pipe  Line  Company  to  make  a  10-year 
contract  to  supply  the  Chelsea  Gas  Light  Company  with  48,000,000 
cubic  feet  annually  at  thirty  cents  a  thousand,  there  is  no  need  of 
apprehension.  And  one  need  not  fear  confiscatory  legislation.3  The 
immediate  cause  of  reduced  rates  may,  at  times,  be  one  or  another 
form  of  compulsion,  but  back  of  it  is  the  working  of  inexorable 
economic  law,  and  as  a  whole,  the  decline  in  rates  works  for  the 
best  interests  of  the  gas  companies. 

1064.  Importance  of  Modern  Management.  Another  requisite  for 
most  successful  operation  is  modern  management.     It  is  hard  to 

1  When  prices  for  illuminating  gas  differed  from  those  of  fuel  gas,  only  the 
former  were  taken.  The  existence  of  some  companies  does  not  extend  back  to 
1885.     These  two  facts  are  of  no  moment  to  the  result. 

2  There  is  some  duplication  in  these  figures,  for  companies  selling  at  more 
than  one  price  have  been  recounted,  e.g.  the  Milwaukee  Company  (by  whose 
courtesy  the  paragraph  is  possible),  but  the  excess  is  not  important. 

•  Cf.  the  recent  decision  of  the  courts  respecting  the  Consolidated  Gas  Company 
of  New  York. 


:;ii;  GAS  COMPANY  BONDS 

overestimate  the  value  of  a  policy  of  aggressive  advertising  and 
public  education  in  gas  ma  Iters.  Many  concerns  circulale  among 
their  customers  pamphlets  of  instruction  regarding  the  proper  use 
and  economy  of  gas;  maintain  sales  departments  with  canvassers, 
and  stores  for  the  demonstration  and  sale  at  or  near  cost  of  gas 
appliances,  and  a  corps  of  inspectors  whose  services  are  offered 
gratuitously  to  those  in  need  of  any  sort  of  help  in  problems  of 
lighting.  The  value  of  one  feature  of  such  management  is  signifi- 
cantly indicated  by  some  figures  from  the  recent  annual  report  of 
the  Springfield  (Mass.)  Gas  Light  Company.  Operating  in  a  group 
of  towns  of  90,000  population  it  furnishes  fuel  for  16,000  gas  stoves. 

The  Bonds 

1065.  The  Bondholder's  Point  of  View.  It  has  seemed  desirable  in 
this  chapter  to  enter  into  more  detail  than  usual  concerning  the 
conduct  of  the  business  in  question.  There  is  a  dearth  of  handy  in- 
formation about  the  financing  of  the  gas  industry.  Little  has  been 
written  from  the  bondholder's  point  of  view.  The  tendency  is  to 
associate  gas  bonds  with  "  industrials "  and  therefore  they  have 
lost  caste,  if  they  ever  possessed  it,  with  that  uninspiring  class  of 
investors  which  buys  "  nothing  but  high-grade  securities."  As  far 
as  safety  is  concerned,  first  and  good  consolidated  mortgage  bonds 
of  some  of  the  companies  mentioned  here,  or  of  many  others  that 
might  be  mentioned,  are  a  higher  grade  of  security  than  many  trunk 
line  first  mortgage  railroad  bonds  in  the  South  and  West,  and  are  an 
infinitely  better  security  than  the  great  majority  of  railroad  junior 
liens,  or  than  the  mortgage  bonds  of  the  street  railways  in  the  cities 
in  which  these  gas  companies  operate. 

1066.  Security.  We  have  recently  passed  through  one  of  the 
regularly  recurring  periods  of  financial  and  commercial  distress. 
Prices  for  everything  except  labor  and  the  necessities  of  life  have 
been  severely  scaled — bonds  among  them.  As  respects  bonds,  it  is 
a  question  in  what  proportion  the  decline  has  been  purely  sympa- 
thetic, and  due  to  monetary  conditions,  or  due  to  real  lessening  of 
the  margin  of  safely.  But  there  is  no  question  at  all  that  the  margin 
of  safety  has  almost  been  wiped  out  in  not  a  few  railroad  and 
street  railway  bonds:  the  two  most  popular  kinds  of  public-service 
corporation  bonds. 

1067.  The  Effect  of  Hard  Times.  It  is  equally  true  that,  so  far 
as  the  effect  upon  earnings  of  general  unsettled  conditions  is  con- 


GAS  COMPANY  BONDS  347 

cerned,   the  margin  of  safety  is   as  great  among  the  sound   and 
thoroughly  established  water  and  water-power  companies  and  gas 
companies  as  it  was  in  1905.     In  the  case  of  water  companies  and 
water-power  companies,  as  stated  in  the  proper  place,  this  is  due 
to  fixed  minimum  revenues,  theoretically  insured,  so  to  speak,  by 
their  contracts  with  consumers,  and  on  the  other  hand  by  a  kind 
of  operating  charges  (having  little  to  do  with  wages  and  materials) 
that  hardly  varies  from  year  to  year.     In  the  case  of  large  gas 
companies  in  the  great  cities  it  is  due  to  the  fact  that  gas  is  no 
longer  a  commodity  to  be  classed  among  the  luxuries,  but  rather 
among  the  domestic  necessities,   and  even  economies.     People  do 
not  curtail  their  ligbt  in  hard  times.     If  gas,   as  a  fuel,  should 
ever   become   predominantly   commercial   rather   than   domestic, — 
should  be  more  generally  employed  to  drive  engines  than  to  light 
rooms  and  cook  food,  the  margin  of  safety  for  gas  bonds  might  be 
affected.    But  no  such  development  is  to  be  foreseen  during  the  life 
of  present  outstanding  loans.    The  normal  annual  increase  in  gross 
business  is  about  10  per  cent.    Financial  panics  and  physical  catas- 
trophes do  not  usually  produce  decreases  in  gross,  but  merely  a 
lessened  rate  of  increase.     The  operating  expenses  are  somewhat 
more  variable  than  those  of  hydro-electric  power  companies  (because 
of  the  item  materials  purchased),  and  therefore  exhibit  less  sta- 
bility, but  the  result  upon  annual  surplus  is  not  very  appreciable. 
1068.    Investment  Suggestions.     As  regards  gas  securities,  by  im- 
plication the  investor  has  been  advised  to  buy  only  the  mortgage 
bonds  of  large  and  thoroughly  established  companies  in  cities  of 
75,000  population  and  over ;  but  the  matter  of  population  is  relative. 
Cities  in  the  South,  for  instance,  with  a  large  proportion  of  scat- 
tered poor-white  or  colored  population  should  have  that  fact  dis- 
counted, and  some  growing  cities  with  less  than  50,000  inhabitants 
are  perfectly  safe.     We  have  already  noted  that  the  greater  the 
congestion,  the  greater  the  per  capita  consumption.     Often  the  in- 
crease in  land  values  alone  is  a  noteworthy  reinforcement  of  mort- 
gage security  in  growing  cities.    We  have  yet  to  hear  of  any  such 
companies  going  to  the  wall  in  a  business  depression.    As  to  fran- 
chises, their  tenor  is  important  in  all  public  franchise  corporations, 
although  gas  companies  are  not  usually  held  in  the  law  to  be  public 
service  corporations.    Many  are  operating  under  perpetual  charters ; 
some,  like  the  Milwaukee  Gas  Company,  have  exclusive  franchises 
and  are  a  pure  monopoly ;  others,  like  the  Laclede  Gas  Company  of 
St.  Louis,  are  immune  by  the  terms  of  their  charters  from  rate 


348  GAS  COMPANY  BONDS 

regulation  by  city  or  slate.  Of  course  the  bonds  should  mature 
be  fori*  the  franchise.  .Many  gas  corporations  are  controlled  through 
stock-ownership  and  run  by  large  operating  companies  such  as  the 
American  Light  and  Trait  ion  Company,  the  United  Gas  Improve- 
ment Company,  the  North  American  Company,  and  the  Pacific  Gas 
and  Electric  Company.  This  should  insure  the  economical  and 
efficient  management  we  have  spoken  of  and  at  the  same  time  give 
the  investor  an  inkling  of  the  true  equity  in  the  concern  above  the 
bonds  that  interest  him,  for  by  a  little  inquiry  be  may  learn  what 
was  paid  by  the  holding  company  for  the  capital  stock.  Those  to 
whom  the  bog}r  of  competition  with  electricity  looms  large,  may 
buy  many  good  issues  of  consolidated  companies  that  furnish  their 
communities  with  both  kinds  of  light. 

1069.  Market  and  Yield.  Having  found  the  bonds  that  most 
nearly  satisfy  his  requirements,  the  investor  should  expect  to  ob- 
tain them  at  such  price  as  to  net  him  from  4^  to  oj  per  cent7 
according  to  the  condition  of  the  bond  market  and  the  excellence  of 
the  security.  If  he  purchases  for  business  reserves  or  under  any 
conditions  requiring  possible  quick  disposal  he  may  find  prominent 
issues  for  which  there  is  always  a  broad  and  ready  market, — indeed 
issues  listed  on  the  principal  exchanges;  although  the  fact  that  they 
are  listed  will  not  facilitate  the  sale  so  much  as  it  will  prove  a  con- 
venience in  ascertaining  the  approximate  price  he  can  obtain.  But 
apart  from  certain  issues,  which,  whether  listed  or  not,  sell  at 
higher  prices  because  of  their  broader  market,  the  investor  buys  to 
hold,  just  as  he  buys  the  bonds  of  street  railways,  and  of  power 
companies,  and  of  irrigation  districts,  and  in  so  doing  pays  only 
for  what  he  most  desires:  safety  and  high  income.  If  he  has  to 
sell  he  anticipates  the  delay  incident  to  the  disposal  of  uncurrent 
securities,  not  expecting  to  get  the  selling  conveniences  for  which 
he  has  not  paid. 


CHAPTER  XXYII 
WATER  COMPANY  BONDS 

1070.  Of  all  public  service  issues,  none,  perhaps,  is  more  simple 
of  understanding  than  Water  Company  Bonds.  These  are  not  to  be 
confused  with  Water  Power  (sometimes  called  Hydroelectric 
Power)  Bonds,  nor  with  the  water  bonds  issued  by  municipalities. 
What  is  meant  are  bonds  issued  by  companies  that  supply  to  mu- 
nicipalities, corporations,  and  individuals  the  advantages  of  hydrant 
and  faucet  for  delivering  water  piped  primarily  as  liquid  rather  than 
as  power. 

1071.  Conditions  Affecting  the  Water  Supply.  Water  companies 
are  not  so  dependent  on  steadiness  of  flow  as  power  companies, 
because  it  is  so  much  easier  to  store  the  fluid  than  the  energy;  but 
the  ultimate  source  of  supply  must  be  unfailing  from  one  year  to 
another.  Steam  generators  may  substitute  energy  when  water- 
power  fails,  but  there  is  no  substitute  for  the  supply  of  a  water 
company.  It  ought  never  to  fail.  Therefore,  the  nature,  extent,  and 
permanency  of  the  source,  and  the  facilities  for  storage  over  a  dry 
season  require  thorough  investigation. 

1072.  There  is  no  uniformity  of  law  throughout  the  country  as 
to  the  right  to  draw  water  from  rivers  and  other  sources  of  supply. 
Priority  of  occupancy  and  appropriation  is  the  cardinal  principle 
of  the  arid  states.  Legislation  elsewhere  tends  to  conserve  the  flow 
and  protect  the  quality  of  water  for  the  benefit  of  all.  A  bond 
buyer  will  wish  to  be  satisfied  as  to  the  protection  offered  by  the 
state  to  the  drawing  of  water  for  the  fundamental  uses  of  the 
water  company.  By  law  and  natural  conditions  the  company  should 
be  safeguarded  from  subsequent  appropriation  of  the  supply  for 
irrigation,  the  generation  of  power,  etc. 

1073.  Since  the  use  of  water,  even  for  drinking  and  other  domes- 
tic purposes,  requires  a  certain  amount  of  energy  of  position,  it  is 
a  pertinent  question  as  affecting  economy  of  operation  how  this 
head  is  obtained.  The  gravity  system,  sufficiently  described  in  the 
name,  is  the  most  economical  to  instal  and  maintain.  It  is  adapted, 
of  course,  to  towns  situated  within  reach  of  mountain  heights. 

349 


350  WATER  COMPANY  BONDS 

1074.  The  pumping  system,  common  in  the  flat  country  of  the 
Middle  West,  is  not  only  more  expensive  to  instal  and  maintain, 
since  it  requires  machinery  and  some  lahor,  but  it  is  uneconomical 
in  the  sense  thai  two  sets  of  pumps  are  necessary  for  uninterrupted 
service,  especially  when  the  pumping  is  directly  into  the  mains, 
rather  than  into  stand-pipes.  The  use  of  both  systems  by  one  water 
company  is  not   infrequent. 

1075.  The  Question  of  Quality.  The  water  supply  interests  an 
investigator  in  other  respects  than  in  quantity,  steadiness,  and  per- 
manency.  Water  companies  sometimes  face  a  serious  difficulty  that 
is  unknown  to  power  companies,  in  the  quality  of  the  water  which 
they  serve.  Again  the  presumption  is  in  favor  of  the  gravity  system. 
Water  coming  from  the  heights,  removed  from  settlement  and  manu- 
facturing, is  generally  of  satisfactory  quality;  the  impurities  are 
usually  mechanical  and  can  he  removed  by  sedimentation  in  reser- 
voirs and  settling  basins.  But  water  pumped  from  rivers  is  likely 
to  contain  vegetable  impurities  which  can  be  eliminated  only  by 
filtration.  Therefore  it  is  usual  to  maintain  testing  laboratories  at 
the  pumping  stations  to  make  frequent  if  not  daily  examination  of 
the  supply  for  both  chemical  and  bacteriological  impurities. 

1076.  Filtration,  however,  is  not  necessarily  expensive;  and  the 
majority  of  modern  plants  are  equipped  with  filtration  systems. 
Consumers  ordinarily  do  not  object  to  paying  for  pure  water;  and  a 
company's  efforts  to  supply  it,  to  the  advantage  of  health  and  life, 
usually  meet  with  adequate  recognition  and  approval. 

1077.  In  a  considerable  part  of  the  West  there  is  no  potable 
water  to  deliver;  the  supply  from  the  mains  is  too  brackish.  There 
may  sometimes  be  relation  between  this  fact  and  an  unwillingness 
of  the  inhabitants,  generally,  to  pipe  from  the  new  mains.  In  the 
long-settled  East,  rural  communities,  comfortably  supplied  with 
wells,  may  be  reluctant  to  change  because  of  prejudice,  inertia,  or 
frugality. 

1078.  The  growth  of  a  city  increases  the  demand  for  water;  but 
if  by  lack  of  proper  foresight  the  source  of  supply  has  been  located 
too  near  the  city,  the  water  may  be  contaminated.  The  well-known 
history  of  New  York's  public  supply  has  analogues. 

1079.  It  is  of  the  utmost  importance  that  the  quality  of  water 
served  be  above  suspicion.  It  is  a  most  despicable  trick  of  cut- 
throat finance  to  arouse  in  a  community  distrust  of  its  water  supply 
in  the  interest  of  a  change  of  regime,  as  from  private  to  municipal 
ownership; — or  in  order  to  depress  the  price  of  a  company's  se- 


WATER  COMPANY  BONDS  351 

curities.    Whatever  chances  of  success  the  scheme  has  are  best  in 
insular  communities. 

1080.  From  the  economic  point  of  view,  water  companies  are  very 
favorably  situated  as  to  their  supply.  In  a  sense,  water  is  their 
raw  material,  and  is  obtained  free  of  cost  except  that  of  pumping 
and  purifying.  If  the  supply  is  good  and  permanent,  earnings  run 
no  risk  from  price  changes  in  the  raw  material.  There  may  be 
transportation  charges, — and  right  heavy, — as  in  the  public  works 
of  Los  Angeles,  if  the  source  is  distant  many  miles ;  but  the  "  cost 
of  production,"  as  distinguished  from  the  cost  of  plant  and  proper- 
ties, is  low  in  relation  to  earnings. 

1081.  Generally  the  water  supply  is  a  natural  monopoly  in  that 
there  is  never  a  substitute  for  the  raw  material,  and  generally  the 
company  owns  all  the  commercially  practicable  sources.  Competi- 
tion, relying  on  lessened  costs  or  superior  service,  cannot,  like 
Moses,  strike  the  rock  for  this  material.  Less  even  than  gas  lighting, 
street  railroading,  and  telephony,  does  water  service  lend  itself  to 
competition.  In  fact  the  writer  knows  of  no  city  where  there  is 
competition  in  the  same  district.  Large  cities  may  be  served  by  two 
or  more  companies, — London  has  six  (now  municipal)  water  com- 
panies, each  of  which  operates  in  its  own  section, — but  it  is  to  be 
doubted  if  any  cities  have  companies  competing  in  the  same  sec- 
tion^  

1082.  Conditions  Affecting  the  Water  Demand.  It  is  truly  said 
that  the  demand  for  water  is  as  certain  and  constant  as  the  de- 
mand for  food,  and  it  is  equally  true  that  increase  in  demand 
is  as  certain  as  increase  in  the  population  of  communities  large 
enough  to  be  served  by  water  companies.  Indeed  the  demand 
for  piped  water  in  this  country  is  like  population  in  this  respect, 
that  it  never  decreases.  The  question  is  merely  as  to  the  rate  of 
increase.  Therefore,  the  only  instances  in  which  we  may  fear  that 
established  water  companies  may  fail  for  lack  of  demand  for  what 
they  have  to  offer,  is  when  the  communities  they  serve  are  wiped 
out  by  some  great  catastrophe,  or  by  the  failure  of  the  crops, 
product,  or  industry  upon  which  the  community  thrived. 

1083.  Even  the  fire  and  earthquake  in  San  Francisco,  and  the 
flood  in  Galveston,  did  not  cause  suspension  of  business  by  the 
waterworks  companies  of  these  cities.  Although  the  dividend  on 
the  Spring  Valley  Water  Company  of  San  Francisco  was  suspended 
in  1907,  the  surplus  for  that  year  was  over  300  per  cent,  of  the 
previous  highest  surplus.    We  know  of  no  waterworks  company  in 


t 


352  WATER  COMPANY  BONDS 

this   country    which    has    subtended    business   owing   to    a   catas- 
trophe. 

1084.  The  Plant  and  the  Business.  When  a  water  service  has  been 
intelligently  instituted  and  built  in  good  faith,  the  elements  of 
chance  and  danger  are  remote  from  the  other  departments  of  the 
business.  The  plant  itself  is  not  subject  to  rapid  depreciation,  and 
it  is  almost  immune  from  fire.  Repairs  and  renewals  made  neces- 
sary by  wear,  or  the  progress  of  invention,  are  few.  The  mains,  of 
cast  iron  pipe,  have  an  indeterminately  long  life.  Cyclones,  floods, 
and  conflagration  will  not  affect  them.    Hardly  anything  but  earth- 

juakes  can. 

1085.  The  dependability  of  the  water  supply  business  is  subject 
to  the  proviso  that  in  the  community  there  is  a  real  need  of  piped 
water,  and  that  the  plant  was  honestly  constructed  of  fair  materials. 
Unfortunately,  manufacturers  of  piping,  pumps,  or  other  material, 
and  general  contractors  often  covenant  with  a  small  town  to  supply 
it  with  water  protection  against  fire,  in  order  to  find  a  profitable 
outlet  for  materials  and  labor.  The  building  of  waterworks  offers 
an  excellent  opportunity  to  bury  the  evidences  of  cheap  material, 
and  construction  and  labor.  Thus,  in  the  past,  the  building  of 
waterworks  in  this  country  has  been  overdone. 

1086.  This,  at  least,  was  the  situation  20  years  ago.  In  fact, 
there  was  a  circular  issued  in  1886  by  one  of  the  leading  houses 
devoted  to  the  sale  of  water  company  bonds,  calling  attention  to 
the  fact  that  many  ill-advised  waterworks  properties  were  being 
constructed,  among  which  some  were  promoted  for  purposes  of 
manipulation  only.  Since  that  time,  however,  the  inevitable  weed- 
ing-out  process  of  intelligent  competition  has  hindered  such  prac- 
tices and  at  present  bond  buyers  are  not  likely  to  suffer  from  them. 

1087.  The  comparative  simplicity  of  putting  a  water  company 
on  its  feet  and  operating  it  until  a  customer  is  found  for  the  plant 
and  the  securities  has  attracted  many  into  the  field  who  have 
not  sufficient  initiative,  and  capacity  for  organization,  to  undertake 
similar  ventures  in  public  lighting  and  transportation.  Here  lies 
the  danger  in  water  bonds.  The  safeguard  (as  always)  is  reliance 
in  the  painstaking  and  intelligent  examination  of  the  property  and 
the  company's  condition  which  any  of  the  better  bond  houses  will 
give. 

1088.  In  the  simplicity  of  the  business  problems  of  the  water 
companies  one  is  reminded  again  of  the  water  power  companies. 
Neither  have  fire  or  labor  troubles  to  contend  with.    When  water 


WATER  COMPANY  BONDS  353 

pipes  are  metered  (as  they  should  be,  especially  in  pumping  plants) 
then  there  is  something  to  be  done,  but  usually  the  office  of  a 
water  company  is  as  apathetic  as  the  corridor  of  a  country  savings 
bank. 

1089.  Capitalization  and  Earnings.  Without  an  engineer's  re- 
port there  is  no  way  of  ascertaining  what  is  the  fair  capitalization 
for  a  water  company,  because  the  conditions  under  which  the  sup- 
ply is  obtained  vary  so  widely.  The  necessary  excess  of  net  earn- 
ings over  fixed  charges  can  be  smaller  than  in  any  other  kind  of 
private  corporation  because  of  the  stability  of  earnings.  It  will 
be  well  to  remember  that  the  prime  element  of  security  is  not  ma- 
terial assets,  such  as  those  behind  steamship  and  equipment  bonds, 
easily  convertible  into  money  on  foreclosure,  but  in  the  assurance 
of  stable  and  increasing  earnings,  based  on  an  inevitable  demand 
for  water.  The  per  capita  indebtedness  of  the  company,  computed 
on  the  population  served,  is  a  poor  criterion  of  fair  capitalization. 
An  examination  of  15  water  companies  in  the  United  States  serving 
communities  of  from  3,500  to  365,000  inhabitants  shows  a  bonded 
debt  per  capita  ranging  from  $12.50  to  $78.88,  and  an  average  of 

1090.  The  stability  of  operating  and  selling  conditions  is  reflected 
in  earnings.  With  a  virtually  costless  raw  material,  and  a  reliable 
demand  at  a  fixed  rate,  and  freedom  from  competition,  except  from 
wells  and  similar  sources  of  supply  already  established,  it  is  not 
astonishing  that  the  earnings  of  water  companies  are  not  affected  by 
business  depression.  As  long  as  the  population  of  cities  keeps  in- 
creasing, so  long  should  the  earnings  of  established  water  companies 
increase  in  fair  proportion.  If  anything  further  can  strengthen 
the  case,  it  may  be  recalled  that  water,  particularly  as  supplied  for 
domestic  purposes,  is  paid  for  in  advance,  by  reason  of  the  initial 
deposit  required ;  and  all  bills  are  paid  at  the  offices  of  the  company, 
so  that  it  does  not  have  even  the  expenses  of  collection.  Water 
companies  market  their  product  also  without  the  need  or  expense 
of  a  selling  force,  or  of  advertising. 

1091.  Management.  But  the  inference  is  not  that  the  business  of 
supplying  water  to  communities  runs  entirely  of  itself.  The  matter 
of  management  is  important ;  only  the  importance  lies  in  the  friendly 
relation  of  the  management  to  the  municipality,  rather  than  in  the 
necessity  of  technical  qualifications  of  a  high  order.  Hence,  local 
management  is  to  be  desired,  when,  as  usually,  that  entails  favor- 
able effect  upon  local  sentiment.    If  water  is  now  supplied  at  a  flat 


354  WATER  COMPANY  BONDS 

rate,  and  it  becomes  advisable  to  introduce  meters,  or  if  there  is 
hydrant  or  other  municipal  business  to  be  had  or  kept,  officials 
skilled  in  diplomacy,  and  not  antagonistic  to  the  voters  or  city 
government,  greatly  aid  the  company's  welfare. 

1092.  Contracts  and  Franchises.  In  the  large  majority  of  com- 
panies the  chief  contract  is  with  the  city.  The  objects  for  which 
a  municipality  may  need  water  are  numerous.  There  are  the  ordi- 
nary uses  to  which  water  is  put  in  any  public  building.  Par- 
ticularly water  is  needed  for  street  hydrants:  for  sprinkling  streets 
and  extinguishing  fires.  The  duration  of  this  municipal  contract, 
and  the  possibility  of  its  abrogation  if  the  terms  are  broken  are 
matters  to  be  considered  if  a  large  part  of  the  company's  income 
is  derived  from  this  source. 

1093.  Not  only  a  considerate  management  but  reasonably  favor- 
able rates  will  be  necessary  to  insure  a  renewal  of  the  contract  on 
favorable  terms,  at  its  expiration,  and  to  discourage  any  thought 
of  starting  a  separate  plant  for  the  public  uses  of  the  city,  if  this 
is  physically  possible,  or  the  thought  of  buying  out  the  existing 
plant  for  municipal  ownership. 

1094.  Although  naturally,  and  inevitably,  municipal  ownership 
and  operation  of  industries  is  economically  unsound,  nevertheless  we 
have  lived  so  long  with  the  idea,  that  former  instinctive  prejudices 
are  dying  out,  and  when  a  real,  or  supposedly  real,  advantage  from 
such  ownership  appears,  public  service  corporations  are  in  danger 
of  their  existence.  Even  in  New  England,  this  year,  a  hot  wave  com- 
bined with  some  scarcity  and  impurity  of  ice  brings  serious  talk 
of  public  ice  plants  in  Hart  lord  and  New  Haven.  In  the  former 
city,  at  least,  the  matter  is  before  the  common  council.  With  much 
more  right  and  likelihood  will  a  city  contemplate  Ihe  absorption 
of  a  public  service  company  that  controls  such  a  natural  monopoly 
as    the    supply    of    water. 

1095.  Theoretically,  at  least,  municipal  ownership  should  not 
prejudice  the  interests  of  bondholders.  It  may  even  strengthen 
the  security,  because  the  city  may  guarantee  the  bonds  in  assuming 
the  indebtedness;  but,  practically,  any  change  in  the  status  quo  of 
a  security  is  liable  to  work  injury,  at  least  for  a  time. 

1096.  The  ideal  franchise  of  any  company  is  without  time  limit. 
Communities  are  coming  to  realize  the  value  of  their  gifts  of  public 
rights,  and  seldom  will  renew  them  on  terms  as  satisfactory  as 
before.     Therefore  the   longer   the  duration  of  the  franchise   the 


WATER  COMPANY  BONDS  355 

better.     If  limited,  it  should  outlast  the  life  of  the  bonds  by  a  few 
years  at  least. 

1097.  Another  point  in  relation  to  contracts  and  franchises  in- 
vites comment.  If  the  company's  charter  requires  in  so  many 
words  that  the  water  served  must  be  pure,  there  opens  the  question 
of  interpretation.  Purity,  as  applied  to  water,  the  commercial 
product,  is  a  relative  term.  It  is  conceivable  that  some  ill-wisher, 
with  ends  to  serve,  might  cause  a  company  considerable  trouble  on 
this  score,  if  it  was  worth  while. 

1098.  Amortization.  When  the  franchises  are  perpetual  there  is 
not  that  great  need  of  the  gradual  amortization  of  the  debt  which 
obtains  if  the  privilege  of  doing  business  expires  within  a  few  years 
of  the  debt's  maturity.  Although  water  company  property  is  subject 
to  slower  depreciation  than  steamship,  timber,  and  equipment  proper- 
ties, yet  amortization  should  not  be  neglected,  for  one  cannot  speak 
too  strongly  of  the  propriety  of  instituting  sinking  funds,  or  of  serial 
repayment  for  the  protection  of  bond  issues  of  all  public  service 
corporations  of  whatever  kind,  and  whatever  conditions  may  obtain, 
respecting  the  standing  of  the  company.  If  water  bonds  are  not 
safe  without  them,  no  kind  is. 

1099.  It  is  for  lack  of  sinking  fund  protection  that  the  principal 
of  the  First  Mortgage  6  per  cent,  bonds  of  the  Escanaba  (Mich.) 
Water  Works  Company,  due  on  October  15,  1906,  still  remains  un- 
paid, although  interest  at  5  and  6  per  cent,  is  being  irregularly 
paid  and  indorsed  on  the  bonds.  All  this  in  the  face  of  the  fact  that 
the  net  income  for  1909  was  reported  as  f 23,458.26,  and  the  average 
net  income  for  the  past  nine  years  as  $17,175.62,  and  that  the  com- 
pany has  recently  expended  $40,000  upon  a  filter  plant.  There  is 
nothing  but  lack  of  inclination  to  prevent  the  bondholders  from 
stepping  in  and  operating  the  property.  But  the  trouble  and  expense 
of  this  proceeding  would  have  been  rendered  unnecessary  by  the 
establishment  of  an  adequate  sinking  fund. 

1100.  Water  Bonds  in  Foreclosure.  This  leads  to  another  advan- 
tage that  water  bonds  possess  in  the  comparative  simplicity  of 
operating  the  plant.  If  the  bondholders  cannot  obtain  full  satis- 
faction in  foreclosure  proceedings,  they  might  do  worse  than  run  the 
plant  themselves.  What  is  quite  impossible  in  railroading  is  very 
feasible  in  this  case. 

1101.  Viewed  in  all  its  aspects  the  purchase  of  the  bonds  of 
well-established  water  companies  is  to  be  encouraged,  when  con- 
vertibility is  not  essential  to  the  investment.     And  even  in  con- 


356  WATER  COMPANY  BONDS 

vertibility  they  are  superior  to  irrigation,  steamship,  timber,  real 
estate,  and  some  other  kinds  of  issues.  If  municipal  water  bonds 
are  the  best  class  of  municipals,  the  bonds  of  private  water  are, 
with  the  possible  exception  of  gas  bonds,  the  best  class  of  public 
service  corporation  securities. 


CHAPTER  XXVIII 
WATER  POWER  COMPANY  BONDS 

1102.  Brevity  overcomes  propriety  in  the  vernacular  of  business. 
We  bow  to  custom  and  speak  of  Street  Railway  Bonds  for  con- 
venience, when  we  mean  something  broader.  So  now  instead  of 
Hydro-Electric  Power  Bonds,  the  descriptive  title,  we  write  Water 
Power  Bonds  and  mean  something  narrower. 

The  title  "  Hydro-Electric  Power  Bonds,"  however,  is  slightly  too 
narrow  for  the  subject  in  hand,  since  the  sources  from  which  com- 
panies properly  associated  with  these  securities  derive  their  income 
is  by  no  means  confined  to  electricity  generated  from  the  fall  of 
water.  But  the  primary,  and  generally  original,  revenue  is  from 
hydro-electric  power.  As  a  complement  to  it  steam-generated 
electric  power  from  auxiliary  stations  is  often  produced  in  connec- 
tion with  rivers  of  great  variability  of  flow,  or  rivers  from  which  all 
possible  power  is  immediately  to  be  taken.  These  stations  are 
usually  emergency  reserves,  to  fall  back  upon  should  the  dam  give 
way,  or  the  water  prove  insufficient  during  a  period  of  drought. 
Steam  stations  are  not  necessarily  located  near  the  water  power,  but 
rather  where  coal  is  procurable  to  best  advantage,  and  this  may  be 
in  the  city  where  the  power  is  principally  marketed.  A  third  and 
often  important  source  of  revenue  is  derived  from  the  sale  of  hy- 
draulic power  to  local  manufactories  at  or  near  the  falls.  Naturally 
this  form  of  power  does  not  bring  a  high  price — it  is  sometimes  sold 
as  low  as  $4.50  per  h.p. — but  requiring  only  simple  machinery  and 
converting  into  profit  what,  at  the  time,  would  otherwise  be  waste 
water,  it  proves  worthy  of  consideration.  Another  source  of  reve- 
nue, which  may  prove  very  important,  though  from  the  bondholders' 
standpoint  highly  speculative  during  the  early  stages  of  a  company's 
development,  is  that  derived  from  industrial  operations  conducted, 
directly  or  indirectly,  through  stock  ownership  by  the  power  com- 
pany itself. 

1103.  A  notable  instance  is  the  Shawinigan  Water  and  Power 
Company  of  Shawinigan  Falls,  Province  of  Quebec.  This  company, 
in  its  infancy,  found  itself  in  a  wilderness  with  one  of  the  greatest 

357 


358  WATER-POWEK  COMPANY  PONDS 

natural  water  powers  in  the  world.  Potentially  capable  of  over 
100,000  h.p.,  its  nearest  market  was  Montreal,  85  miles  away.  The 
circumstances  were  such  as  to  serve  excellently  for  illustration  of 
the  possibilities  of  the  various  kinds  of  power.  Obviously  a  steam 
auxiliary  was  unnecessary  in  the  early  stages  of  development,  for 
by  reason  of  the  immense  llowage  and  a  drainage  area  as  yet 
mostly  undeforested,  no  scarcity  of  water  at  any  season  of  the  year 
was  to  be  anticipated.  A  market  for  10,000  h.p.  was  found  at  Mon- 
treal. High-tension,  long-distance  transmission  lines  carried  it  ;  and 
this  proving  entirely  feasible,  power  was  also  transmitted  to  other 
almost  equally  distant  points  for  lighting,  mining,  and  smelting. 
At  the  falls  the  company  also  established  and  took  a  large  or  con- 
trolling interest  in  industries  which  manufactured  products  that 
were  either  best  obtained  by  the  employment  of  electricity,  such 
as  carbide  and  aluminum,  or  else  adapted  to  the  use  of  hydraulic 
power,  such  as  pulp  and  paper.  The  establishment  of  local  in- 
dustries there  has  rapidly  created  a  town  with  demands  of  its 
own  for  power  and  light,  and  even  traction.  Thus,  by  a  multiplicity 
and  variety  of  kinds  of  power,  and  kinds  of  power  contracts,  and 
kinds  of  markets,  the  company  is  strongly  fortifying  itself  against 
possible  future  reverses.1 

1104.  Water-Power  and  Steam-Power  Plants.  Steam-power  plants, 
serviceable  as  auxiliaries,  may  prove  dangerous  as  competitors. 
Local  physical  and  franchise  conditions  will  determine.  The  in- 
centive to  competition  from  steam-generators  is  the  comparatively 
low  first  cost,  which  we  will  say  averages  $75  per  h.p.  as  compared 
with  $150  for  the  hydro-electric  plant.  But  current  costs  all  favor 
the  later,  for  coal,  which  has  an  efficiency  of  about  25  per  cent.-, 
must  be  bought,  but  water  preserves  about  75  per  cent,  of  its  effi- 
ciency through  the  turbines. 

1105.  The  Bonds:  Nature  of  the  Security.  It  will  be  acknowledged 
readily  that  the  purchase  of  electric  power  bonds  should  be  attended 
with  more  detailed  scrutiny  than  is  required  for  most  other  classes. 
It  is  advisable  to  remember  this,  because  they  are  usually  offered 
the  public  during  the  company's  construction  period;  but  even 
with  these  handicaps  the  element  of  risk  need  not  discourage  those 
who  are  willing  to  take  the  necessary  pains  to  investigate  all  the 
conditions  affecting  the  security.  What  these  conditions  are, 
broadly  speaking,  is  developed  in  the  following  paragraphs. 

1  About  a  year  ago  the  company  purchased  $700,000  of  the  stock  of  its  chief 
distributor,  the  Montreal  Light,  Heat,  and  Power  Company. 


WATER  POWER  COMPANY  BONDS  359 

1106.  The  security  for  hydro-electric  power  bonds  is  revenue  de- 
rived from  the  sale  of  power.  This  revenue  is  determined  by  the 
extent  and  reliability  of  the  power-supply  and  of  the  power-demand. 
Fortunately  both  these  factors  are  determinable  in  the  main  when 
the  bonds  are  issued.  If  not,  the  bonds  shouldn't  be  bought  until 
conditions  are  settled.  For  convenience,  the  factors  will  be  dis- 
cussed under  this  two-fold  classification. 

1107.  Conditions  Affecting  the  Power-Supply.  The  prime  neces- 
sity, of  course,  is  water, — for  conversion  into  foot-pounds  or  horse- 
power. Preliminary  estimates  of  a  stream's  potential  horse-power 
often  prove  wide  of  the  mark.  Engineer's  optimism,  as  it  appears  on 
the  preliminary  offering,  should  for  safety's  sake  be  somewhat  dis- 
counted. The  figures  may  err  as  often  by  understating  as  by  over- 
stating the  facts,  but  a  power  proposition  that  does  not  look  at- 
tractive, even  after  reasonable  deductions  for  the  sake  of  con- 
servatism, is  not  a  desirable  investment.  In  figuring  earning  ca- 
pacity one  should  also  deduct  the  necessary  and  very  generous  per- 
centage of  waste  involved  in  converting  the  energy  of  falling  water 
into  electricity  for  distribution,  and  in  transmitting  the  electricity 
to  its  markets;  and  one  should  ascertain  whether  in  the  first  place 
the  rating  was  based  upon  the  minimum  flow  of  the  river  through 
a  series  of  years  past,  and  for  how  many  consecutive  years  readings 
had  been  taken,  and  whether  the  readings  were  from  government  or 
private  gauging,  and  who,  in  general,  was  responsible  for  the  hydrog-' 
raphy  upon  which  the  estimates  were  based. 

1108.  The  Drainage  Area.  Even  if  a  river's  flow  bears  a  good 
record  in  the  past,  future  conditions  are  quite  another  matter. 
Perhaps  the  source  of  supply  is  concentrated  in  a  few  springs  which 
future  deforestation  may  dry  up,  or  perhaps  the  topography  of  the 
country  is  such  that  the  head  waters  may  be  diverted,  without  legal 
redress,  for  purposes  of  irrigation,  etc.  It  is  well  to  have  as  many 
thousands  of  square  miles  of  drainage  area  as  possible.  Mountain 
sources  are  excellent,  for  melting  snows  in  summertime  bring  de- 
pendable reinforcement  to  the  otherwise  dwindling  flow.  In  these 
respects  nature  favors  the  great  Montana  power-plants  on  the  Mis- 
souri River,  for  the  Missouri's  head  waters  are  in  the  snows  of  the 
Rockies  and  her  flow  greatest  during  the  warm  months  when  the 
requirements  for  irrigation  would  otherwise  be  embarrassing.  One 
of  the  causes  for  the  ultimate  Pacific  Coast  supremacy  of  the  cities 
of  Puget  Sound  is  the  unlimited  and  unfailing  source  of  electrical 
power  in  the  nearby  snow-capped  Cascade  Range.     But  although 


360  WATER  POWER  COMPANY  BONDS 

mountain  sources  are  a  welcome  reinforcement  in  the  dry  season 
they  <lo  not  necessarily  (end  to  steadiness  in  flow,  as  the  Missouri 
amply  demonstrates.  In  this  respect  there  is  a  great  variability 
among  rivers. 

1109.  The  Storage  Reservoir.  It  is  to  the  ultimate  sources  of 
water  supply  snch  as  mentioned  that  one  must  look  for  the  amount 
and  stability  of  flow  from  month  to  month  and  season  to  season. 
The  daily  flow  is  regulated  to  avoid  waste  by  creating  an  imme- 
diate and  artificial  source  and  storage  of  supply.  In  estimating 
potential  horse-power  engineers  figure,  as  a  rule,  upon  a  ten-hour 
day,  but  under  ordinary  conditions  of  nature,  the  water  during  the 
other  fourteen  hours  is  not  lost,  but  stored  behind  the  dam  in  a 
reservoir  which  is  usually  an  enlargement  of  the  river  and  de- 
pendent for  its  continence  upon  the  banks  of  the  river  and  the 
dam-wall.  When  water  is  low,  the  reservoir  level  is  raised  by  the 
election  of  flash-boards  upon  the  crest  of  the  dam.  The  pondage, 
or  capacity,  of  this  reservoir  is  of  the  utmost  moment  in  tiding  the 
company  over  a  period  of  dry  weather  and  in  determining  the 
power-capacity  of  the  plant.  Particularly  is  this  true  of  those 
sections  of  the  country  that  have  a  dry  season.  One  should  assure 
himself  that  all  condemnation  proceedings  covering  this  area  have 
been  brought  to  successful  conclusion  and  that  all  other  necessary 
riparian  rights,  both  up  and  down  stream,  have  been  secured  with- 
out possible  future  liability.  Some  rivers,  of  course,  have  such 
contour  that  the  storage  of  water  is  impossible. 

1110.  The  Power-Plant  Construction.  Then,  as  to  the  dam  itself, 
and  the  power-house, — it  sometimes  happens  that  quicksand  is  en- 
countered in  the  bed  of  the  river,  or  some  other  deterrent  to  a  solid 
foundation  for  the  dam.  Even  preliminary  borings  do  not  always 
discover  these  weaknesses.  It  is  well  if  the  site  of  the  dam  has 
a  rock  ledge  for  a  wall-foundation,  and  the  rockier  the  natural  for- 
mation of  the  storage  basin  the  better.  In  northern  water-powers 
frazil,  or  anchor,  ice  often  has  been  a  serious  menace  to  efficiency 
in  late  winter,  but  this  difficulty  is  now  more  easily  overcome. 
The  deposit  of  silt  is  another  obstruction.  Some  sites  are  of  such 
formation  that  the  ice  and  silt  factors  are  negligible.  The  power- 
house should  be  so  situated  that  it  would  not  be  carried  away  if 
the  dam  should  go.  It  seems  almost  as  if  no  perfection  of  masonry 
or  mathematics  could  achieve  an  absolutely  sure  resistance  to  the 
force  of  accumulated  waters.  Herein  is  the  greatest  element  of 
chance  concerning  water-power  construction;  the  most  approved 


WATER-POWER  COMPANY  BONDS  3G1 

modern  work  occasionally  goes  down  before  an  overwhelming  flood. 
From  this  cause,  when  a  series  of  dams  is  situated  upon  the  same 
river,  the  upper  ones  are  a  menace  to  those  down  stream. 

1111.  Herein  lies  the  greatest  risk  in  purchasing  water-power 
securities  when  the  plant  is  in  the  construction  stage.  Although 
the  number  of  physical  mishaps  is  relatively  small,  sometimes  they 
seem  as  unforeseeable  and  unpreventable  as  earthquakes  and  tidal 
waves. 

1112.  The  corollary  evil  is  that  estimates  of  construction,  figured 
with  great  care  and  in  good  faith,  will  sometimes  fall  short  of  the 
actual  expense  in  such  an  amount  that  when  the  plant  is  completed 
at  the  additional  cost  it  cannot  earn  a  fair  return  on  the  capitaliza- 
tion. This  is  the  dilemma  of  a  well-known  Southern  property. 
$4,000,000  has  been  spent  on  it— all  the  original  estimate  called 
for,— and  $3,000,000  or  $4,000,000  more  is  needed.  But  in  this 
case  the  company  disregarded  the  correct  estimate  of  the  con- 
struction offered  by  one  of  the  best  hydro-electric  engineers  in 
the  country,  in  favor  of  the  lower  and  more  agreeable  estimate  of 
less  capable  advisers. 

1113.  Conditions  Affecting  the  Power  Demand.  Granting  that  the 
company  in  question  makes  a  satisfactory  showing  in  all  respects 
affecting  its  power  supply,  it  is  equally  important  that  it  be  able  to 
meet  the  requirements  of  profitable  demand,  for  doubtless  many 
more  companies  suffer  from  commercial,  than  from  engineering 
imperfections. 

1114.  The  Power  Market.  The  broadest  business  consideration  is 
the  location  and  character  of  the  market.  The  proximity  of  a  city 
is  desirable  though  not  imperative,  as  we  have  seen.  The  delivery 
of  power  one  hundred  miles  from  the  source  of  supply  is  no  longer 
an  experiment.  If  men  financially  interested  in  the  power  com- 
pany control  neighboring  industries  requiring  its  product,  as  is 
often  the  case,  so  much  the  better,  for  enlightened  cooperation  re- 
sults between  producers  and  consumers.  Certain  districts,  by 
reason  of  their  natural  resources,  and  certain  industries,  are  prac- 
tically dependent  upon  electric  power  to  do  business  in  competition 
at  a  profit.  This  is  getting  to  be  particularly  so  in  mining  and 
smelting,  and  for  all  operations  requiring  portable  power.  The 
South  finds  it  highly  desirable  in  the  cotton  industry.  The  moun- 
tainous Northwest  will  soon  demand  it  for  transportation  owing 
to  the  greater  tractive  power  of  electricity.  In  fact,  to  the  very 
minutest  of  domestic  employments,  the  market  for  electricity  is 


362  WATER-POWEB  COMPANY  BONDS 

broadening  to  such  an  extent  that,  in  time,  every  volt,  one  may  say, 
will  be  in  requisition  throughout  the  country.  The  age  of  steam 
is  surely  passing.  But  mines  are  eventually  worked  out,  and  mills 
will  shut  down,  so  the  investor  will  see  to  it  that  a  diversity  of 
interests  is  responsible  for  the  revenues  of  the  company  to  which 
his  money  is  loaned.  Not  too  great  a  proportion  of  the 
power  should  be  sold  for  any  one  object  or  to  any  one  organi- 
zation. 

1115.  In  estimating  the  amount  of  power  which  should  be  taken 
by  a  certain  industry  or  community,  one  cannot  count  on  secur- 
ing the  custom  of  all  those  to  whose  profit  it  certainly  would  be 
to  turn  from  steam  power  or  steam-generated  electric  power  to 
hydro-electric.  Small  manufacturers  are  often  inert  and  skeptical, 
and  averse  on  general  principles  to  capital  expenditures.  The 
process  of  enlightenment  is  slow.  In  some  instances  it  may  be 
found  that  for  certain  technical  reasons  the  proposed  change 
would  be  an  advantage  more  apparent  than  real.  For  instance, 
whatever  the  local  price  of  coal,  oil,  or  electricity,  woodworking 
plants  often  will  find  it  cheaper  to  consume  their  own  waste  for 
power  rather  than  to  purchase  power  in  the  open  market. 
Therefore,  weight  should  be  given  to  the  estimates  of  none  but 
experienced  electrical  engineers,  in  considering  the  market  for 
1  tower. 

1116.  Competition.  Since  the  contracts  for  power  are  usually 
of  shorter  duration  than  the  life  of  the  bonds,  a  renewal 
upon  favorable  terms  is  best  safeguarded  by  the  absence  of 
competition.  The  State  of  Washington,  the  Niagara  zone, 
and  the  Ottawa  River  District,  Province  of  Ontario,  Canada,  are 
open  to  criticism  in  this  respect.  On  the  other  hand  this  dis- 
advantage is  often  offset  by  the  certain  future  grow-th  in  demand 
for  power.  Competition,  again,  may  be  mechanically  possible,  but 
commercially  impracticable,  or  may  be  politically  stifled  by  ap- 
parently exclusive  franchises,  only  to  be  resuscitated,  as  recently 
in  Montreal,  under  a  different  dispensation.  Each  case  must  be 
settled  upon  its  merits.  The  Montreal  situation  is  illustrative  of 
the  whole  matter.  The  Montreal  Light,  Heat,  and  Power  Com- 
pany, which  has  had  a  monopoly  of  the  business  in  Montreal 
proper,  has  been  selling  power  there  at  $47.  The  Canadian  Power 
Company,  which  has  secured  entrance,  will  no  doubt  cut  into  that 
price,  but  the  position  of  the  older  company  is  in  no  way  im- 
periled, for  160,000  h.p.,  or  more  than  both   of  these  companies 


WATER  POWER  COMPANY  BONDS  363 

will  produce,  is  now  being  manufactured  from  coal  at  higher  than 
$47  cost.  Therefore,  apart  from  new  power-demand,  both  com- 
panies can  look  to  this  field  for  business. 

1117.  But  in  Montreal,  and  Northern  communities  generally, 
the  mere  fact  that  electric  power  is  cheaper  than  coal  power  is 
not  necessarily  sufficient  to  warrant  its  employment.  Many  in- 
dustries require  heat  as  well  as  power.  For  instance,  the  four- 
drinier  machines  of  the  paper  companies  are  regularly  run  by  steam- 
power,  because  rolls  must  be  heated  and  the  steam  can  advantage- 
ously be  used  for  this  purpose  after  being  passed  through  an  engine 
to  give  the  necessary  power. 

1118.  Nature  of  the  Contracts.  In  order  to  meet  the  contingen- 
cies that  have  been  mentioned  and  to  avoid  the  consequences  of  com- 
mercial depression,  it  is  well  for  a  new  company  to  be  tied  up  with 
long  time  contracts  which  of  themselves  will  pay  a  large  proportion 
of  the  fixed  charges.  There  are  two  sides,  however,  to  this  long 
time  contract  matter  and  the  layman  is  likely  to  overlook  the  other. 
A  company  in  its  infancy  is  not  often  in  a  position  to  dictate,  and 
its  early  contracts  are  not  usually  on  as  good  terms  as  its  later 
ones.  Prices  for  hydro-electric  power  are  steadily  rising  with  the 
increase  in  cost  of  coal  and  with  the  growth  of  the  country.  A 
power  company  does  well  to  have  some  short-term  contracts  ma- 
turing in  such  way  as  to  adjust  themselves  to  bettering  conditions 
on  much  the  same  principle  that  a  trust  fund  distributes  the  maturi- 
ties of  its  loans.  There  are  companies  with  long  10,000  h.p.  contracts 
outstanding,  which  they  were  glad  to  sign  a  decade  ago,  but  to  be  re-' 
leased  from  which  now  would  be  well  worth  $50,000  a  year  to  them. 
The  power  company  should  be  protected  in  its  contracts  by  a  clause 
making  them  temporarily  voidable  in  case  of  "  circumstances  be- 
yond control."  The  intending  bond  purchaser  may  seem  hyper- 
critical, but  no  harm  is  done,  if  the  company  is  dependent  upon 
one  or  two  big  contracts,  should  he  require  the  specific  terms  in 
which  they  are  couched.  Much  depends  upon  the  contract.  As  to 
actual  horse-power  prices,  conditions  vary  so  that  no  general  state- 
ment avails.  Prices  range  from  $10  to  $50,  but  either  extreme 
looks  suspicious. 

1119.  Responsibility  of  the  Lessees.  As  much  more  depends  on 
the  other  parties  to  the  contract.  In  the  case  of  small  or  new 
power  companies,  a  glance  at  the  lessees'  rating  with  the  com- 
mercial agencies  will  not  come  amiss. 

All  the  investigation  that  has  been  advised  is,  of  course,  not 


3G4  WATER-POWER  COMPANY  BONDS 

necessary   in  purchasing   the  first  mortgage  bonds  of  established 
and    prosperous  power   companies. 

1120.  The  Bonds:  Income  Yield.  But,  as  suggested,  one  of  the 
most  favorable  lea  tares  about  investment  in  hydro-electric  power 
bonds  is  the  relative  accuracy  with  which  future  results  may  be 
forecasted  from  given  conditions,  even  before  one  stone  has  been 
laid  upon  another.  Accountants,  collaborating  with  engineers,  can 
estimate  with  some  precision,  after  the  major  power  contracts  have 
been  signed,  what  will  be  the  minimum  income  of  the  company 
after  a  year's  operation.  This  is  not  possible,  of  course,  in  the 
case  of  many  other  kinds  of  companies  that  ordinarily  issue  bonds, 
for  no  other  kinds  have  a  minimum  revenue  insured  by  contracts. 
Hydro-electric  power  bonds  are  therefore  peculiarly  adapted  to 
purchase  in  the  underwriting  and  construction  periods,  when  as 
five  or  six  per  cents,  they  may  be  had  at  a  generous  discount  and 
sometimes  with  a  stock  bonus.  So  purchased  they  are  what  the 
papers  call  "  a  businessman's  investment,"  meaning  by  this,  a  good 
conservative  speculation. 

1121.  Other  Investment  Advantages.  Beside  the  distinguishing 
characteristics  of  an  insured  minimum  revenue,  electric  power 
companies  are  peculiarly  free  from  several  of  the  ordinary  em- 
barrassments of  most  public-service  corporations.  The  franchises 
of  the  former  are  usually  perpetual,  and  in  some  instances,  granted 
by  special  acts  of  Congress.  At  one  remove  from  popular  contact, 
power  companies  are  not  very  liable  to  political  attack  on  their 
prices  and  business  conduct.  They  are,  in  the  nature  of  the  case,  not 
directly  subject  in  any  great  degree  to  labor  troubles,  fire,  or  legis- 
lation, nor,  except  as  holding  companies,  especially  amenable  to 
the  ills  of  business  depression.  Once  constructed,  equipped,  and 
paid  for  with  the  proceeds  of  the  sale  of  securities,  further  expendi- 
tures can  usually  be  met  out  of  income,  or  at  any  rate,  the  en- 
tanglements of  a  complicated  system  of  funded  indebtedness  can  be 
avoided.  Therefore  the  accounting  is  easily  followed  and  the  com- 
pany's condition  ascertainable  by  its  bond  creditors. 

1122.  The  Operating  Ratio.  With  proper  capitalization  the 
operating  and  fixed  charges  should  bear  a  low  ratio  to  gross  earn- 
ings, as  compared,  for  instance,  with  railroad  and  street  railway 
companies,  and  in  relation  to  stability  the  ratio  may  be  expected 
to  vary  less  than  that  of  railroads  and  more  than  that  of  street 
railways.  For  a  decade  the  average  operating  ratio  of  the  interstate 
railroads  of  the  country  has  run  from  04  to  GO  per  cent.    The  average 


WATER-POWER  COMPANY  BONDS  365 

ratio  of  purely  hydro-electric  companies  is  probably  between  25  and 
35  per  cent.  The  constancy  of  the  ratio  is  determined  by  the  char- 
acter of  the  contracts,  for  the  operating  charges  are  comparatively 
free  from  the  variables:  material  and  labor.  This  low  and  stable 
operating  ratio  is  the  impressive  advantage  to  offset  the  uncer- 
tainties of  the  construction  period. 

1123.  Appreciation.  Bonds  of  good  companies,  bought  with  care 
during  the  period  of  development,  need  only  the  improved  demand 
that  comes  when  confidence  is  established  by  substantial  earnings 
and  a  fair  dividend  record,  to  show  moderate  appreciation. 

1124.  Marketability  and  Investment  Value.  Somewhat  removed 
from  speculative  influences  they  are  not  subject  to  the  extremes  in 
price  that  offer  opportunities  for  profit  and  loss,  in  liquidation. 
The  market  is  narrow.  Power  companies  are  not  in  the  public  eye; 
the  average  capitalization  is  small ;  they  are  usually  fostered  by  a 
single  banking  house;  in  most  states  they  are  not  subject  to  super- 
visory control  by  commission,  and,  in  general,  they  are  not  in  posi- 
tion to  profit  market-wise  by  publicity.  Yet  the  bonds  of  successful 
companies  do  not  go  begging,  except  in  the  very  worst  of  times,  and 
perhaps  they  suffer  less  depreciation  than  classes  of  securities  in 
which  ownership  is  more  frequently  transferred.  Water-power 
bonds,  then,  are  a  particularly  desirable  investment  for  those  who 
are  capable  of  making  sound,  independent  investigations,  and  who 
seek  a  large  return  with  reasonable  security,  rather  than  a  high 
degree  of  convertibility. 


*gf  A  U    ?    ~^r  4*  ,  CHAPTER  XXIX 

REAL  ESTATE  BONDS 

1125.  A  class  of  securities  has  recently  sprung  into  notice,  par- 
ticularly in  New  York  City,  which,  although  not  new  to  this 
country,  and  indeed  quite  common  in  Europe  for  many  years  past, 
is  of  such  recent  vogue  with  us  as  to  have  received  less  attention 
from  financial  writers  than  present  circumstances  warrant.  This 
class  may  be  called  Real  Estate  Bonds.  As  the  title  suggests,  the 
bonds  are  the  obligations  of  companies  doing  more  or  less  of  a  real 
estate  business,  whether  as  principals  or  as  agents;  and  the  ulti- 
mate security  behind  the  bonds  is  real  estate,  which,  up  to  the 
present  time,  has  been  that  situated,  for  the  most  part,  within,  or 
upon  flip*  outskirts  of  large  cities.  Much  is  made  by  real  estate 
companies  of  the  kind  of  security  back  of  the  bonds  they  offer. 
Nothing,  they  say,  can  be  more^J^ble  and  permanent  than  values 
attaching  to  ground,  especially  in  cities,  for  the  steady  and  yet 
rapid  increase  in  metropolitan  realty  values,  extending  in  America 
over  at  least  arcentury,  has  no  parallel  in  other  kinds  of  wealth. 
As  illustration,  for  many  consecutive  decades  the  tax  records  of 
New  York  exhibit  an  average  yearly  increase  in  land  values  for 
each  decade  of  over  6  per  cent.  Since  1875  the  total  assessed  value 
of  real  estate  in  Manhattan  has  increased  at  the  rate  of  over  32 
per  cent,  every  five  years.1 

1126.  The  Two  Kinds  of  Bonds.  Real  Estate  Bonds  are,  in  gen- 
eral, the  outcome  of  one  or  the  other  of  two  entirely  distinct 
situations.  The  commoner  and  more  strictly  commercial  involves 
the  organization  of  a  company  with  sufficient  capital  to__acajiire 
property  for  improvement,  or  the  equity  in  such  property,  and  the 
issuance  of  the  company's  notes  (euphoniously  called  "bonds"), 
against  the  cost  or  equity.  The  rentals  usually  will  much  more 
than  offset  the  interest  charges;  and  the  residue,  together  with  the 
proceeds  from  the  sale  of  JJie.debentures,  will  yield  a  working  bal- 
ance with  which  to  purchase  a/* second  parcel  or  group  of  parcels, 

1  Including  Wards  23  and  24,  which  before  the  consolidation  were  a  part  of 
the  Bronx. 

366 


REAL  ESTATE  BONDS  367 

subject  to  improvement,  and  so  on  ad  infinitum.  The  denomination 
of  these  debentures  is  usually  multiples  of  $100,  and  the  interest 
rate  6  per  cent.,  and  the  selling  price  par. 

1127.  The  other  and  better  situation  is  that  of  a  company  acting 
more  particularly  as  mortgage  brokers,  which  acquires  a  number 
of  real  estate  first  mortgages,  has  them  guaranteed,  perhaps,  in 
another  company  (which  should  be  absolutely  independent,  but 
seldom  is),  and  issues  against  them  bonds  to  the  amount  of  the 
mortgages.  These  bonds  are  rightly  called  "  First  Mortgage  Cer- 
tificates," and  are  practically  the  same  as  first  mortgage  bonds. 
This  kind  of  real  estate  mortgage  bond  is  now  common  through- 
out the  greater  part  of  Continental  Europe.  Its  history  is  unim- 
peachable and  it  ranks  in  security  with  government  and  municipal 
issues.  Since  the  issuing  company's  direct  profit  lies  in  the  differ- 
ence between  the  rate  yielded  by  the  mortgages  and  the  rate  paid 
on  the  certificates  issued  the  denomination  of  the  certificates  or 
bonds  is  likely  to  be  less  than  5  per  cent.;  say  4£  per  cent.  Like 
mortgages,  the  certificates  are  usually  sold  at  par. 

1128.  It  is  patent  that  the  first  class  we  are  considering  is  com- 
posed of  strictly  speculative,  and  the  second  class  of  strictlxjn^ 
vestment  issues.  Both  have  excellent  records  thus  far,  due  partly 
to  the  character  of  the  companies  operating  on  these  plans,  partly 
to  their  financial  connections,  and  partly  to  their  fields  of  operation ; 
but  no  Real  Estate  Bonds  should  be  bought  without  even  closer 
scrutiny  than  is  given  the  ordinary  security,;  for  they  are  seldom 
prepared  and  sold  by  experienced  banking  houses,  and  in  this 
country  they  have  not  had  the  "  seasoning "  that  only  time  and 
test  can  give  a  class  of  securities. 

1129.  In  common  with  industrial  issues,  Real  Estate  Bonds  .suf- 
fer from  the  lack  of  publicity  and— ««^efvision  which  state  com- 
missions exercise  over  public  service  corporations  and  their  obli- 
gations. A  possible  source  of  future  trouble  is  to  be  expected  in 
the  fact  that  if  Real  Estate  Bonds  should  become  common,  number- 
less small  companies  would  rush  into  the  field  and  issue  worthless 
paper  on  which  to  float  their  enterprises.  As  yet,  people  are  so 
suspicious  that  it  takes  a  bond  with  some  merit  to  sell.  Brains 
and  capital  are  required  to  start  an  industrial  or  semi-public  enter- 
prise in  this  day  of  commercial  combinations;  but  anybody  with  a 
dollar  can  enter  the  real  estate  business  and  for  a  time  make  a 
show  on  slender  equities. 

1130.  Real  Estate  Debentures.    The  legal  status  of  the  first  class 


3G8  REAL  ESTATE  BONDS 

of  Real  Estate  Bonds  is  not  usually  presented  to  the  investor  with 
entire  candor.  A  railroad  company  issuing  unsecured  junior  obli- 
gations which  are  merely  notes,  frankly  calls  them  debentures.  We 
seldom  see  Real  Estate  Bonds  so  entitled.  In  the  interest  of  sound 
finance  it  is  desirable  to  secure  and  preserve  an  accurate  and  uni- 
form nomenclature.  The  general  characteristics  of  Debentures,  as 
understood  in  the  United  States,  are  treated  in  Chapter  IX. 

1131.  Security.  Real  Estate  Debentures,  usually  called  "bonds" 
or  "  certificates,"  are  a  direct,  but  unsecured  charge  upon  the  assets 
of  the  company.  It  is  imperative  to  know  the  nature  of  these 
assets.  They  will  probably  be  found  to  consist  chiefly  of  real  estate 
and  investments  in  mortgages.  A  large  proportion  of  the  real 
estate  should  be  rental  property  in  developed  sections  of  great 
cities.  A  large  proportion  of  the  rental  property  should  be  business 
property.  The  amount  of  assets  in  cash  or  demand  loans  should  be 
sufficient  to  meet,  not  only  the  immediate  interest  requirements, 
and  the  probable  demands  of  those  bondholders  who  may  choose 
to  avail  themselves  of  any  delayed  redemption  clause  in  their 
mortgage  deed,  but  also  to  carry  out,  in  times  of  business  depres- 
sion, without  liquidation  of  the  more  permanent  assets,  the  com- 
pany's immediate  undertakings  for  the  development  of  its  unim- 
proved property,  if  it  has  any. 

1132.  The  ratio  of  bond  liability  to  rental  property  assets  should 
be  noted,  and  also  the  amount  of  mortgages  upon  the  property 
owned, — especially  upon  the  rental  property.  For  it  should  not 
be  forgotten  that  these  mortgages  are  obligations  upon  the  com- 
pany pi-iov  to  its  out  standing  Debentures.  It  should  also  be  remem- 
bered that  the  bondholders,  who  may  have  loaned  the  company 
millions,  perhaps  several  times  its  capital,  have  no  voice  in  the 
company's  management,  and  that  there  is  nothing  but  the  good 
faith  of  the  company  to  restrict  within  reasonable  bounds  the 
amount  of  either  these  prior  mortgages  or  the  bonds  themselves. 
The  bonds  are  probably  an  unlimited  issue.y  Since  the  bonds  are 
not  mortgage  securities,  and  could  not  be  enforced  by  foreclosure 
against  specific  property,  their  security  is  dependent  upon  the 
general  health  of  the  company.  Having  no  voting  power  they  com- 
pare unfavorably,  in  some  respects,  with  cumulative  preferred 
stock,  and  as  mandatory  charges  they  sap  the  credit  of  the  com- 
pany in  a  wray  that  preferred  stocks  do  not. 

1133.  Net  Yield.  With  these  disadvantages  in  mind  it  is  not 
unnatural  that  the  yield  of  the  Debentures,  in  ordinary  times,  is 


REAL  ESTATE  BONDS  369 

from  6  to  7  per  cent.  If  the  bonds  were  issued  as  cumulative  pre- 
ferred stock,  the  position  of  the  company  as  respects  these  se- 
curities would  be  stronger,  for  in  times  of  real  estate  depression 
dividends  could  be  passed  temporarily;  but  since  the  interest  on 
Debentures  is  as  much  an  obligation  as  the  principal,  the  company 
under  these  conditions  would  be  obliged  to  sell  some  of  its  holdings^ 
at  a  most  disadvantageous  time,  or  else  by  mortgaging  them  still 
further,  to  weaken  the  security  in  order  to  maintain  interest  pay- 
ments. Under  the  circumstances  6  per  cent,  is  none  too  much  to  pay  > 
in  interest.. 

1134.  Negotiability.  Few  classes  of  bonds  (if  any)  receiving 
public  recognition  have  a  narrower  market.  Since  the  security  in 
each  case  is  dependent  upon  the  character  of  the  company,  and  since 
the  conditions  under  which  each  company  works  are  so  distinct, 
the  bonds  can  have  no  recognized  and  current  value  as  a  class. 
To  offset  this  disadvantage,  it  is  customary  to  insert  a  redemption 
clause  permitting  the  owner  to  liquidate  the  bond  a  year  or  two 
after  purchase  upon  a  few  months'  notice,  by  paying  a  considerable 
bonus.  Hedged  with  such  restrictions  the  redemption  feature  loses 
the  greater  part  of  its  value;  for  if  one  redeems  his  bonds,  the  pre- 
mium offsets  a  large  part  of  the  interest  obtained;  and  the  in- 
vestor would  get  no  more,  if  as  much,  on  his  money  for  the  period, 
than  if  he  had  left  it  in  the  savings  bank. 

1135.  Suppose  the  issuing  company  offers  to  redeem  a  loan, 
bought  at  par,  any  time  after  two  years,  for  such  a  price  as  will 
net  the  investor  3  per  cent., — what  he  might  obtain  if  he  had  it  in 
a  bank  on  call.  We  will  say  that  seven  years  later  the  investor  is 
obliged  to  avail  himself  of  this  redemption  pledge.  If  the  bonds 
bore  6  per  cent,  interest  the  company  would  have  paid  him  42  per 
cent,  in  all;  but  by  redeeming  the  bonds  they  are  under  obligation 
to  pay  him  only  3  per  cent.  Therefore  he  must  return  21  per  cent., 
or  in  other  words,  the  company  redeems  his  bond  at  79  and  interest. 
In  the  legitimate  bond  business  this  redemption  clause  would  be 
called  a  "  joker." 

1136.  Duration  and  Appreciation.  As  collateral,  little  can  be 
said  in  favor  of  Real  Estate  Debentures.  A  bank  looks,  not  only 
for  good  security,  but  also  for  a  reasonably  responsive  market,  and 
dislikes    to   take    the    trouble   to   investigate   unknown    securities. 

Another  peculiarity  is  that,  since  Real  Estate  Debentures  are 
ordinarily  of  unlimited  issue,  they  often  have  no  fixed  ma- 
turity as  an  issue,  but  are  retired  10  or  15  years  after  the  date 


370  REAL  ESTATE  BONDS 

of  purchase.  Moreover,  they  are  almost  invariably  subject  to  call 
at  par  after  a  few  years.  The  early  maturity,  the  possibility  of  re- 
demption, the  unlimited  nature  of  the  issue,  and  the  narrowness  of 
the  market,  make  appreciation  next  to  impossible. 

1137.  Record  and  Future.  The  record  of  these  Debentures  has 
been  good.  The  big  real  estate  and  holding  companies  in  our  large 
cities  have  fairly  constant  factors  to  deal  with, — barring  conflagra- 
tions. Fire  and  business  depression  are  the  two  greatest  unpre- 
ventable  dangers;  insurance  will  largely  guard  against  the  one, 
and  an  ample  liquid  surplus  lessen  the  other.  Debentures  are 
now  frequently  put  forth  with  sinking  fund  provisions.  But  what 
is  needed  to  give  the  best  standing  possible  to  the  bonds  is  the 
mediation  of  a  supervising  trust  company  acting  under  a  trust 
agreement  which  contains  clauses  restricting,  in  some  measure, 
the  companies'  plenary  power  to  create  debts.  The  Debentures  are 
never  likely  to  become  a  merchantable  commodity  until  they  are 
issued  with  such  standard  forms  and  safeguards  as  to  be  acceptable 
to  bond  houses.  At  present  they  are  bought  as  mortgages  are,  in 
the  comfortable  illusion  that  they  are  not  speculative,  and  not 
subject  to  fluctuation  in  value.  All  arguments  to  that  effect  by  the 
issuing  real  estate  companies  are  ingenuous  and  incite,  among  the 
banking  fraternity,  distrust  of  those  who  make  them. 

1138.  Real  Estate  Mortgage  Bonds.  If  in  strict  terminology,  the 
first  class  should  be  called  Real  Estate  Debentures,  the  second 
should  be  entitled  Real  Estate  Collateral  Trust  Mortgage  Bonds. 
That  is  to  say,  the  bonds  are  secured  by  a  lien  on  first  mortgages. 

1139.  Security.  Issued  in  the  manner  we  stated  at  the  outset, 
the  considerations  to  engage  the  investor  are  few,  but  should  be 
well  looked  into.  Since  the  selling  company  makes  its  direct  profit 
not  in  commissions  nor  in  bond  "  watering,"  but  in  the  difference 
in  yield  between  the  first  mortgages  and  the  bonds,  there  is  neces- 
sarily the  temptation  to  put  up  as  collateral,  mortgages  with  a  high 
interest  rate.  These  may  not  usually  be  had  upon  desirable  central 
income  property,  or  if  so,  only  because  an  undue  amount  has  been 
loaned  upon  the  piece.  Therefore,  this  first  mortgage  collateral 
may  well  have  the  payment  of  principal  and  interest  guaranteed 
by  another  and  independent  company  in  unquestioned  standing; 
and  it  goes  without  saying  that  the  validity  of  both  mortgage  deeds 
and  property  titles  should  likewise  be  guaranteed.  Many  guaran- 
tees, however,  are  of  such  a  provisional  nature  as  to  be  worthless.  No 
qualifications  should  be  accepted.    It  is  unfortunately  the  case  that 


REAL  ESTATE  BONDS  371 

the  guaranteeing  company  is  usually  interested  either  in  the  issuing 
company  or  in  the  mortgages.  It,  therefore,  results  that  all  the 
mortgages  are  guaranteed  in  the  one  company;  but  it  would 
strengthen  the  bonds  if  the  guaranty  were  distributed  among  sev- 
eral companies  in  the  manner  of  insurance  underwriting. 

1140.  There  is  a  sense,  however,  in  which  a  degree  of  greater 
security  is  obtained  by  distribution,  in  that  the  collateral  behind 
the  bonds  is  mortgages  on  more  than  one  piece  of  property. 

1141.  In  the  nature  of  the  case,  as  the  collateral  mortgages  ex- 
pire, others  must  be  substituted  to  preserve  the  integrity  of  the 
security.  An  investor  cannot  keep  track  of  shifting  collateral,  nor 
can  he  know  the  correctness  of  the  company's  property  appraisal, 
from  which  the  amounts  of  the  mortgages  are  determined.  From 
the  first  of  these  weaknesses  the  usual  collateral  trust  bond  (which 
does  not  permit  the  substitution  of  collateral),  is  exempt.  But 
from  another  standpoint  a  shifting  mortgage  collateral  is  not  a 
weakness,  since,  if  the  mortgaged  property  deteriorates,  better 
mortgages  may  be  substituted  when  the  deteriorated  mortgage  ex- 
pires. Both  classes  of  Real  Estate  Bonds  demand  the  repose  of  much 
confidence  in  the  issuing  company. 

1142.  To  a  certain  extent,  the  nature  of  the  collateral,  and  the 
investment  policy  of  the  company,  may  be  judged  by  the  terms 
of  the  trust  agreement  given  by  the  Mortgage  Bond  Company  to 
the  trustee  for  the  bondholders.  These  terms  will  have  to  do  with 
the  kinds  and  locality  of  properties  that  will  be  acceptable,  the 
maximum  ratio  of  the  mortgage  to  the  appraised  value  of  each 
property,  and  matters  concerning  insurance  and  a  proper  distribu- 
tion of  risk. 

1143.  Net  Yield.  When  bonds  are  thus  secured  by  guaranteed 
first  mortgages  upon  real  estate  they  may  be  tax-exempt  within  the 
state,  as  in  New  York,  and  bring  a  correspondingly  better  price. 
Or  viewed  in  another  way,  they  are  a  substitute  in  convenient  de- 
nominations for  mortgages,  and  under  proper  auspices  have  the 
same  grade  of  security,  and  therefore  sell  at  approximately  the 
same  income  return  as  high  grade  guaranteed  mortgages,  namely 
about  4-J  per  cent.,  in  the  East. 

1144.  Denomination.  They  have  no  great  advantages  over  regular 
guaranteed  real  estate  mortgages,  except  this  of  denomination. 
The  best  sort  of  security  for  any  loan  is  one  with  a  known  value 
and  a  known  market.  Central  business  property  generally  has 
both,   broadly  speaking.     But  first  mortgages  cannot  be  had  in 


372  REAL  ESTATE  BONDS 

small  amounts  upon  such  property.  It  is  the  highly  useful  func- 
tion of  the  First  Mortgage  Real  Estate  Bond  to  give  the  same  sort 
of  real  estate  for  security  to  the  man  with  f  500  or  $2,500  to  invest 
as  he  has  who  loans  $250,000. 

1145.  Negotiability.  Until  Real  Estate  Bonds  are  handled  to  a 
larger  extent  by  bond  houses,  and  have  a  greater  vogue,  the  mar- 
ket must  ordinarily  lie  in  the  issuing  company.  It  is  possible  in 
the  first  class  of  Real  Estate  Bonds,  i.e.  Debentures,  for  the  com- 
pany to  insert  a  clause  permitting  their  redemption  at  holder's 
option,  after  a  term  of  years,  and  upon  long  notice,  because  the 
assets  against  the  bonds  are  salable  property,  and  heavy  demands 
could  be  met  as  a  bank  meets  them:  by  liquidation.  But  in  the 
second  class,  conditions  are  not  so  favorable:  mortgages  cannot 
be  as  readily  liquidated.  And  since  the  security  is  comparatively 
non-negotiable,  usually  the  bonds  so  secured  are  also.  The  market 
then  for  First  Mortgage  Real  Estate  Bonds  is  not  so  good  as  that 
for  Debentures,  and  not  much  better  than  that  for  first  mortgages 
themselves.  It  is,  of  course,  principally  on  the  score  of  negotiability 
that  national  banks  are  not  permitted  to  buy  Real  Estate  Bonds. 

1146.  Duration.  Much  the  same  practice  obtains  for  the  re- 
demption and  repayment  of  the  second  class  as  of  the  first. 
The  bonds  run  from  10  to  15  years  and  are  usually  callable  at  the 
expiration  of  about  half  the  period.  There  is,  therefore,  no  oppor- 
tunity for  great  appreciation. 

1147.  Leasehold  Mortgage  Bonds.  There  is  a  kind  of  bond,  a 
variation  upon  the  usual  First  Mortgage  Real  Estate  Bond,  that  is 
worthy  of  study,  not  because  of  its  present  prominence,  but  because 
of  its  probable  future  vogue :  the  Leasehold  Mortgage  Bond. 

The  leasehold  principle  applied  to  real  estate,  common  enough 
in  England  and  on  the  continent,  is  only  just  obtaining  recognition 
in  this  countiy.  As  central  business  property  in  great  cities  grows 
more  and  more  valuable  it  can  be  developed  to  best  advantage  with 
high  buildings  in  large  parcels.  If  the  person  or  estate  that  owns 
the  land  is  unable  or  unwilling  to  make  the  costly  improvements 
required  to  bring  the  property  to  its  highest  efficiency,  then  it  de- 
volves upon  an  enterprising  tenant,  or  upon  a  lessee  who  purposes 
to  make  his  gains  by  sub-leases  or  rentals.  Since  the  building  or 
buildings  to  be  constructed  at  the  expense  of  the  lessee  will  involve 
heavy  outlay,  he  will  probably  require  the  option  of  renewals  at  the 
expiration  of  the  lease,  and  a  return  to  him  at  that  time,  of  a  fixed 
or  arbitrated  sum  for  the  building  he  has  erected. 


REAL  ESTATE  BONDS  373 

1148.  Security.  Because  of  the  scale  on  which  realty  operations 
are  now  conducted  in  the  larger  cities,  the  lessee  is  probably  a 
corporation,  and  as  such  seeks  to  extend  its  operations  to  the 
scope  of  its  capital.  It  cannot  mortgage  the  land,  which  it  does 
not  own,  but  it  can  mortgage  its  interest  in  the  leaseholds.  A 
mortgage  thus  made  and  duly  recorded  may  be  as  secure  as  if  upon 
the  land  itself,  for  it  is  a  lien  upon  the  only  thing  that  makes  the 
land  valuable,  that  is,  its  earnings;  and,  of  course,  any  mortgage 
upon  the  land,  or  fee,  recorded  subsequently  to  the  leasehold  mort- 
gage, is  second  or  otherwise  junior  to  it.  The  leasehold  as  se- 
curity, or  part  security  for  railroad  bonds  (e.g.  the  New  York 
Central  3^s  of  1997)   is  very  common. 

1149.  Although  the  conditions  under  which  leaseholds  arise 
argue  an  intelligent  and  satisfactory  real  estate  situation,  ab- 
stractly the  discussion  concerning  the  relative  security  of  lease- 
hold mortgages  and  of  land  lien  mortgages  resolves  itself  into 
which  would  suffer  least  if  reduced  to  foreclosure.  Academically, 
it  seems  as  if  the  market  for  real  property  itself  at  present  would 
be  broader  in  this  country  than  that  for  leaseholds,  because  real 
property,  as  a  kind  of  wealth,  is  better  known;  but  in  either  case 
the  probabilities  are  that  the  equity  at  stake  would  be  bought 
in  by  the  interested  bondholders.  Practically,  however,  the  lease- 
hold bondholders  are  favorably  secured  in  this  respect,  as  compared 
with  bondholders  in  general,  since  the  trustee  or  a  bondholders' 
protective  committee  could  conduct  such  a  simple  business  as  rent- 
ing property  controlled  by  the  company;  whereas,  if  the  foreclosed 
mortgage  was  secured  by  such  a  business  as  transportation  or  public 
lighting,  technical  considerations  would  probably  make  it  inadvis- 
able for  the  bondholders  or  their  representatives  to  enter  into  the 
business  for  their  own  account. 

1150.  The  purchaser  of  Leasehold  Mortgage  Bonds  will  do  well  to 
satisfy  himself  as  to  the  following  particulars : 

1.  There  should  be  no  prior  liens,  or  very  immaterial,  upon  the 
land  or  leaseholds. 

2.  The  ground  rents  should  average  several  years  longer  than 
the  longest  bonds. 

3.  The  sub-leases  and  rentals  should  be  of  fair  average  duration 
and  should  not  all  expire  at  one  time. 

4.  The  value  of  the  ground  rent  or  leasehold  interests  should 
be  greatly  in  excess  of  the  authorized  bond  issue;  and  the  value 
should  not  be  taken  at  the  company's  estimate  unless  that  con- 


374  REAL  ESTATE  BONDS 

forms  with  the  estimate  of  a  disinterested  audit  company,  or  to  the 
valuation  made  by  insurance  companies  as  the  basis  of  their  under- 
writing of  the  leasehold  interests. 

5.  The  net  earnings  of  the  lessee  corporation  should  be  several 
times  all  interest  charges  and  sinking  fund  requirements. 

6.  The  situation  and  nature  of  the  properties  and  the  character 
of  the  tenants  should  be  such  as  to  insure  a  low  percentage  of 
vacancies  from  any  cause  whatsoever. 

7.  The  leaseholds  and  properties  should  be  adequately  insured 
to  the  trustee  for  the  benefit  of  the  bondholders,  against  fire  and 
other  usual  insurable  risks;  and  the  fee  titles  should  be  guaran- 
teed. 

8.  An  adequate  sinking  fund  for  the  redemption  of  the  bonds 
should  be  accumulated;  or  much  better,  the  bonds  should  be  re- 
deemed  serially. 

1151.  Eligibility  for  National  Banks.  Although  Real  Estate 
Bonds,  in  general,  are  not  investments  legal  for  national  banks,  it 
happens,  curiously  enough,  that  Leasehold  Mortgage  Bonds  escape 
the  classification  and  are  bought  by  national  banks.  According  to 
the  Treasury  Department  "  Real  Estate  Mortgage  Bonds,  or  bonds 
resting  solely  upon  the  security  of  real  estate,  are  not  considered 
proper  investments  or  securities  for  a  national  bank.  If  the 
bonds  .  .  .  however  .  .  .  are  not  secured  by  real  estate,  but  simply 
by  the  lease  thereof,  they  would  not  come  under  the  classification 
of  Real  Estate  Bonds."  Eligibility  of  leasehold  mortgage  bonds 
should  in  time  give  them  recognition  favorable  to  their  market- 
ability. But,  at  present,  they  are  not  likely  to  have  any  advantage 
in  this  respect  over  other  Real  Estate  Mortgage  Bonds,  unless  they 
are  handled  by  a  bond  house  that  protects  its  clients.  But  since 
the  Leasehold  variety  requires  more  careful  study  than  the  simple 
land  lien  bond,  when  carefully  bought  it  has  the  advantage  of 
greater  income  return  with  an  equal  degree  of  security. 


CHAPTER  XXX 
TIMBER  BONDS 

1152.  The  Lumber  Business.  Mr.  Gifford  Pinchot  estimates  that, 
at  the  present  rate  of  consumption,  all  the  available  timber  in 
the  United  States  would  be  exhausted  within  20  years.  How 
rapidly  the  cut  has  increased  will  be  seen  from  the  following 
table,  which  is  taken  from  a  circular  of  the  Forest  Service  of  the 
Department  of  Agriculture: 

Lumber  Cut  During 

1880  18,125,432,000  feet 

1890  23,842,230,000    " 

1900  35,067,595,000    " 

1907  40,256,154,000    " 

1908  . . . 33,224,369,000    "  1 

Total  Cut,  1880-1907    (estimated) ..  .801,329,932,000    " 

1153.  The  Department  calls  attention  to  the  fact  that  the  in- 
crease in  population  from  1880  to  1900  was  52  per  cent,  but  the 
increase  in  lumber  cut  was  94  per  cent. ;  also  that  consumption  was 
in  excess  of  three  times  the  new  growth. 

1154.  Every  one  knows  what  has  been  the  result  upon  lumber 
prices  in  this  country  of  ours  which  has  been,  and  is  still,  so  grossly 
wasteful  of  its  resources,  and  until  the  last  decade  or  two,  utterly 
ignorant  of  scientific  forestry.  The  effect  upon  the  character  of 
the  lumber  business  itself  has  been  no  less  marked. 

1155.  One  of  the  chief  benefits  of  the  present  aggregation  of 
capital  in  constantly  enlarging  units,  is  in  furnishing  the  sinews 
for  a  single  control  of  a  product  from  its  primitive  state,  through 
tht  processes  of  conversion  into  consumptive  form,  and  transporta- 
tion to  the  wholesale  or  retail  markets.  In  the  long  run,  by  reason 
of  economies  in  operation,  and  standardization  in  service,  either  the 

1  1908  was  a  bad  year  in  the  lumber  industry,  due  of  course  to  building  condi- 
tions following  the  panic. 

875 


376  TIMBER  BONDS 

product  will  be  improved,  or  the  price  to  the  consumer  will  be  less 
than  it  would  be  otherwise,  however  greater  than  in  past  years 
when  consumption  had  not  yet  taxed  the  power  of  production. 

1156.  The  evolution  in  American  business  methods  has  been 
operative  in  the  lumber  industry  as  well  as  in  the  livestock,  steel, 
milk,  and  oil  industries.  Whereas  formerly  a  half-dozen  companies 
were  required  to  convert  a  tree  into  sash,  furniture,  or  paper,  now 
the  lands,  stumpage,  logging  equipment,  mills,  and  sometimes  even 
the  selling  organization,  are  in  unit  ownership  and  direction. 

1157.  There  is,  however,  a  reason  for  conducting  the  lumber 
business  on  a  scale  suggesting  great  commercial  consolidations, 
which  has  no  reference  to  monopolistic  tendencies  in  general.  It  has 
to  do  with  that  conservation  of  which  we  hear  so  much  nowadays. 
If  the  supply  of  wood  should  soon  become  exhausted,  immense  sums 
would  be  lost  which  have  been  necessary  to  the  erection  and  equip- 
ment of  modern  economical  milling  plants  with  their  railroad  and 
river  approaches  and  outlets.  A  way  to  prevent  this  loss  is  to  buy 
tracts  or  "  limits  "  of  such  extent  and  value  as  to  permit  an  annual 
depreciation  charge  from  earnings  sufficient  to  wipe  out  the  cost  of 
the  land  or  lease,  and  of  the  plant.  But  this  is  generally  uneconomi- 
cal as  compared  with  the  policy  of  replacing  stripped  lands  with  new 
growth. 

1158.  The  Origin  of  Timber  Land  Bonds.  Reforestation  is  ac- 
cepted in  France  and  Germany  and  other  European  nations  as  a 
matter  of  course.  One  can  buy  in  New  York  bentwood  furniture 
made  from  third,  fourth,  or  fifth  growth  timber  from  Austrian  for- 
ests. Our  few  forestry  schools,  still  in  the  first  generation,  have 
taught  reforestation  as  their  first  lesson;  and  it  could  well  enough 
be  applied  particularly  by  the  wood  pulp  and  paper  companies, 
which  are  accumulating  wooded  tracts  on  such  a  scale  as  to  admit 
of  cutting  sections  in  rotation,  so  that  on  the  exhaustion  of  vir- 
gin timber,  section  after  section,  in  turn,  would  be  in  proper  age 
for  second  cutting.  We  have  not  quite  reached  this  stage  in  the 
lumber  business  yet. 

1159.  What  is  a  comparatively  easy  problem  for  the  paper  com- 
panies becomes  more  difficult  for  concerns  which  convert  the  better, 
grades  of  stock,  especially  hardwood.  But  the  principal  is  the 
same,  and  nothing  is  needed  but  the  requisite  degrees  of  patience, 
knowledge,  and  capital.  The  longer  the  time  necessary  to  age  the 
particular  woods  grown,  and  the  more  acute  the  demand  for  these 
woods,  the  greater  the  funds  necessary  to  the  undertaking.     So 


TIMBER  BONDS  377 

it  has  come  about  that  lumber  companies  have  been  obliged  to  ap- 
peal for  investment  capital,  as  well  as  speculative,  and  they  have 
turned  to  the  bond  houses. 

1160.  Fifteen  or  twenty  years  ago  a  call  for  investment  money 
from  the  lumber  interests  would  have  met  with  scant  response. 
The  demand  from  other  quarters  was  too  great.  Furthermore,  in- 
vestment principles  had  first  to  be  worked  out,  by  thought  and 
experience,  for  the  more  necessary  transportation  problems,  rail- 
road and  street  railway,  and  interurban,  and  for  the  problems 
of  public  service  in  lighting,  heating,  and  power,  and  for  problems 
of  communication,  the  telegraph  and  the  telephone.  Then,  again, 
a  class  of  wealthy  investors  such  as  we  now  have  in  the  Middle 
West,  had  to  come  into  being,  and  be  made  acquainted  with  the 
application  of  investment  principles  to  industrial  enterprises  of  the 
very  sort  in  which  they  had  won  competence  by  business  speculation. 
Upon  the  fruition  of  these  things  the  field  was  ready  for  timber 
bonds. 

1161.  There  are,  then,  at  least  three  objects  for  the  entrance  of 
lumber  companies  into  the  field  of  bond  finance:  to  accumulate 
timber  lands  against  the  impending  wood  famine,  to  insure  future 
supplies  for  the  expensive  mills  and  plants,  and  last,  but  unfor- 
tunately least,  to  reforest  in  the  interest  of  a  permanent  wood 
supply. 

1162.  The  Requirements  of  Mortgage  and  Deed  of  Trust.  In  the 
evolutional  stages  of  any  business  development,  no  funds  devoted 
to  it  can  be  considered  safe  unless  they  are  secured  by  a  primary 
lien  on  the  larger  part  of  a  company's  entire  assets.  The  value  of 
the  material  property  pledged  should  be  heavily  in  excess  of  the 
amount  of  the  obligation,  and  provision  should  be  made  for  the 
retirement  of  the  debt  in  a  much  more  rapid  ratio  than  the  deple- 
tion of  the  resources  and  the  depreciation  of  the  plant. 

1163.  In  addition  to  the  lien  there  is  sometimes  guaranty  by 
indorsement,  individual,  or  several,  or  joint  and  several.  The  in- 
dorsers  would  naturally  be  men  in  the  lumber  business  with  com- 
mercial rating.  The  added  security  of  indorsement  is  particularly 
acceptable  to  the  class  of  business  men  who  buy  timber  land  bonds. 
A  triple  indorsement  might  give  the  bond  in  their  eyes  the  ad- 
vantage of  being  the  three  name  paper  familiar  to  them. 

1164.  The  Timber  Lands.  Timber  land  bonds  should  be  first 
mortgage  obligations  secured  on  the  fee  of  most,  if  not  all,  the  lands 
owned.     Titles  should  be  searched  by  competent  counsel,  acting 


37S  TIMBER  BONDS 

for  the  banking  house.  Titles  are  sometimes  questionable  in  the 
comparatively  unsettled  country  that  now  furnishes  us  with  most 
of  our  timber.  Because  that  country  is  comparatively  unsettled 
and  less  accessible,  the  title  is  usually  thought  of  as  valuable  only 
in  relation  to  lumber.  But  there  are  timber  land  bonds  outstand- 
ing, notably  some  secured  by  pledge  of  New  England  land,  that 
will  probably  prove  far  from  worthless  without  the  wood,  by  the 
time  the  loans  mature. 

1165.  The  market  value  of  standing  timber  depends  as  much 
on  the  location  of  the  lands  with  reference  to  the  market,  and  on 
the  means  of  transportation  to  it,  as  on  the  lumber  itself.  The 
lands  may  possibly  be  tapped  or  traversed  by  drivable  streams. 
Then  the  bondholders'  money  may  go  into  the  purchase  of  more 
raw  material,  and  not  be  sunk  into  lumber  railways,  the  earnings 
and  usefulness  of  which  are  likely  to  diminish  with  every  year  of 
service.  If  these  streams  can  also  furnish  power  for  saw,  planing, 
pulp,  or  paper  mills,  so  much  the  better. 

1166.  If  a  large  part  of  the  assets  is  ownership  merely  of  stump- 
age,  and  not  of  the  land,  the  bearing  of  this  fact  on  the  future 
of  the  company  may  be  important,  as  well  as  the  terms  on  which 
the  usufruct  reverts  to  the  land  owners. 

1167.  Other  merchantable  perquisites  sometimes  pertain  to  lum- 
ber companies,  and  are  of  value  under  the  mortgage.  In  illustra- 
tion, pine  and  other  coniferous  forests  have  valuable  turpentine 
rights. 

1168.  Because  one  of  the  main  efforts  of  lumber  companies  at 
present  is  to  increase  their  ownership  in  the  "  raw  material,"  it  is 
unusual  for  the  mortgage  to  cover,  not  only  present  property,  but 
all  hereafter  acquired.  Such  a  provision  in  the  deed  would,  of 
course,  be  a  source  of  strength  to  it. 

1169.  The  Plant.  The  lumber  manufacturing  plants  may  or  may 
not  be  a  large  part  of  the  company's  pledged  assets.  The  largest 
plant  in  the  world,  recently  completed  at  a  cost  of  over  $3,000,000, 
is  part  of  the  security  for  a  bond  issue  of  f 3,000,000  authorized. 
The  timber  lands  under  the  lien  are  valued  at  about  $7,500,000. 
The  total  value  of  all  the  property  covered  is  thus  about  three  and 
one-half  times  the  amount  of  the  bond  issue.  If  the  estimates  are 
fair  the  various  ratios  are  adapted  to  the  safety  of  the  bonds. 

1170.  It  is  evident  that  the  mills,  the  kilns,  the  railroad,  and 
logging  equipment,  and  all  the  other  property  and  machinery 
necessary  for  converting  logs  into  lumber,  or  lumber  into  finished 


TIMBER  BONDS  379 

product,  should  bear  as  low  as  possible  a  ratio  of  cost  to  the  value 
of  the  raw  material,  for  the  plant  will  depreciate.  But  just  as 
surely  the  wood  will  appreciate  from  the  present  level  of  prices, 
except  for  temporary  setbacks  due  to  artificial  causes  such  as 
severe  business  depression,  or  the  breakdown  of  the  tariff.  In  the 
East,  the  opening  of  the  Panama  ('anal  may  cause  an  adjustment 
of  the  prices  of  Eastern  and  Western  woods,  due  to  lower  freight 
rates  from  the  Pacific  coast. 

1171.  But  in  these  days  when  most  uncut  virgin  timber  is  so 
far  removed  from  centers  of  population,  it  is  generally  the  build- 
ing of  the  plant  which  gives  marketability  to  the  wood.  Pre- 
sumably the  lands  were  acquired  at  a  low  figure  for  the  very  reason 
that  there  were  then  no  facilities  near  for  working  timber.  Prob- 
ably it  is  still  possible  to  buy  timber  in  the  State  of  Washington 
for  less  than  $1.00  a  thousand  that  will  be  worth  from  four  to  eight 
times  as  much  when  accessible  by  rail. 

1172.  The  Timber.  Occasionally  a  large  part  of  the  timber 
assets  is  already  in  yard  or  mill;  but  generally  we  look  to  the 
standing  timber  as  the  principal  pledge  under  the  lien.  The  value 
of  it  must  be  appraised  in  accordance  with  the  quantity,  kinds, 
quality,  and  (as  just  stated),  accessibility.  Since  this  is  a  self- 
evident  statement,  little  elaboration  is  necessary. 

1173.  The  method  of  appraisal,  in  its  essential  interest  to  the 
bondholder,  is  easy  to  understand.  No  guesswork  is  necessary  as  in 
the  case  of  unmined  coal  or  metals.  When  the  tracts  were  bought 
the  lumber  company  sent  "  cruisers  "  to  ascertain,  with  more  or  less 
approximation,  the  number  of  thousands  of  feet,  or  cords,  in  the 
tracts.  The  banking  house  will  not  be  satisfied  with  this.  It  will 
wish  to  learn  from  disinterested  sources  with  all  the  exactness 
possible.  It  will,  therefore,  have  timber  estimators  and  compass- 
men  sent  out  to  reappraise,  and  report  general  conditions,  viz. :  as 
to  the  greenness  and  general  thriftiness  of  the  wood,  as  to  whether 
the  kinds  are  well-bunched  or  promiscuous,  whether  or  not  the 
plots  are  grouped  in  convenient  logging  distances,  whether  the 
timber  has  been  turpentined,  etc.,  etc. 

1174.  The  quantity  of  timber  is  not  merely  a  matter  of  acreage, 
but  a  matter  of  growth  and  density.  Nor  is  it  a  matter  of  board,  but 
of  log  feet.  According  to  the  purposes  to  which  it  will  be  put,  the 
stumpage  included  in  the  estimate  may  be,  perhaps,  of  8,  10,  or  12- 
inch  logs,  and  up. 

1175.  A  clear  definition  of  what  character  of  timber  is  to  be 


.'{.SO 


TIMBER  BONDS 


estimated  and  entire  confidence  in  the  good  faith  of  the  estimators, 
are  essential  to  satisfactory  returns.  A  gang  of  cruisers  that 
recently  covered  a  timber  property  known  to  the  writer,  brought 
in  an  estimate  five  times  as  great  as  that  of  a  second  gang  which 
worked  over  the  property  independently,  and  at  about  the  same 
time. 

1176.  Timber  Values.  The  great  and  growing  strength  of  in- 
dustrial companies  lies  in  the  possession  of  material  wealth  for 
which  the  demand  is  bound  to  increase  in  greater  ratio  than  the 
supply.  Although,  in  a  sense,  the  future  supply  of  wood  is  not 
fixed  as  that  of  coal  or  metals,  yet  wood  is  of  such  slow  growth 
as  to  be  justly  estimated  on  the  basis  of  a  constantly  increasing 
demand.  The  average  value  per  thousand  feet  at  the  mill  for  all 
lumber  produced  in  this  country  was  $11.13  in  1900,  $12.76  in  1904, 
$16.54  in  1906,  $16.56  in  1907,  and  $15.37  in  1908. 

1177.  There  is  probably  no  material,  not  even  gold  itself,  which 
has  a  future  value  in  exchange  more  assured  than  wood.  The  truth 
of  this,  in  so  far,  at  least,  as  this  country  is  concerned,  is  to  be 
found  in  the  accompanying  tables  which  are  from  a  recent  bulletin 
of  the  Bureau  of  Labor.  Lumber  values  have  had  no  material  set- 
backs in  the  past  20  years  at  least;  and  the  tendency  has  been 
constantly  upward.  Lumber,  therefore,  looked  upon  as  mere  ma- 
terial, is  most  excellent  security  for  bonds. 

1178.  Prices  op  Lumber  and 


Maple:  hard. 

Oak:  white, 
plain. 

Oak:  white, 
quartered. 

Hemlock. 

YEAR. 

Average 
priceper 
M  feet. 

Rela- 
tive 
price. 

Average 
priceper 
M  feet. 

Rela- 
tive 
price. 

Average 
priceper 
M  feet. 

Rela- 
tive 
price. 

Average 
priceper 

M  feet. 

Rela- 
tive 
price. 

Average, 
1890-1899 

$26.5042 
26.5000 
20.5000 
20.50(10 
26.5000 
26.5000 
26.5000 
26.5000 
26.5000 
26.5000 
26.5417 
27.5000 
26.7083 
2.h.5k:;3 

100.0 
100.0 
100.0 
100.0 
100.0 
100.0 
100.0 
100.0 
100.0 
1000 
100.1 
103.8 
100  8 
107.8 
119.5 
117.0 
115.1 
117.0 
121.7 
119.3 

$37.4292 
37.8750 
38.0000 
38.4583 
38.7500 
37.2500 
36.2500 
36.2500 
36.2500 
36.2500 
38.9583 
40.8333 
36.7708 
40.8750 
44.8833 
46.5000 
47.3333 
50.4167 
55.2083 
49.2917 

100.0 

101.2 

101.5 

1027 

103.5 

99.5 

96.8 

96.8 

96.8 

96.8 

104.1 

109.1 

98.2 

1092 

119.8 

124.2 

126.5 

134.7 

147.5 

131.7 

$53.6771 
51.4583 
53.5833 
Mil  101 10 
53.0000 
51.1250 
53.2500 
54.5000 
53.8333 
52.5000 
60.5208 
61  4583 
59.1607 
63.0833 
74.7917 
80.7500 
80.2500 
79.1607 
80.0000 
80.1667 

100.0 

95.9 

99.8 

98.7 

98.7 

95.2 

99.2 

101.5 

100.3 

97.8 

112.7 

120.1 

110.2 

117.5 

139.3 

150.4 

149.5 

147.5 

149.0 

149.3 

$11.9626 

12.5833 
12.4583 
12.2917 
12.0000 
11.7083 
11.1458 
11.1677 
11.0000 
11.7500 
13.5208 
16.5000 
15.0000 
15.8333 
16.7917 
17.0000 
17.8750 
21.8958 
22.2500 
20.8750 

100.0 

1890 

105.2 

1891 

104.1 

102.8 
100.3 

97  9 

1895 

93  2 

1896 

93  3 

1897..                                

92  0 

98.2 

113.0 

1900 

137.9 

125.4 

132.4 

140  4 

1904 

31 .0000 
30.5000 
31.0000 
32.2500 
31.6250 

142.1 

1905 

149.4 

1906 .                           

183.0 

1907 

186.0 

1908 

174.5 

TIMBER  BONDS 


381 


1179.  The  Fire  Hazard.  Unfortunately,  however,  there  is  one 
drawback  to  the  ideality  of  timber  as  security,  and  that  is  the  fire 
hazard.  How  real  the  risk  in  many  sections,  may  be  judged  from 
the  fact  that  the  Lloyds  of  London  are  the  only  association  known 
to  the  writer  which  will  insure  standing  timber.  They  charge  $f> 
a  hundred  and  require  a  detailed  description  of  the  property  for 
judgment  of  its  worth  as  a  risk. 

1180.  Admitting  the  danger,  the  case  is  not  so  bad  as  it  looks. 
In  the  first  place  this  danger  of  fire  is  being  rapidly  lessened  by 
the  organized  efforts  of  private  and  government  patrols.  Secondly, 
perpetual  dampness  or  a  rainy  season  militates  against  fires  during 
the  whole  or  a  part  of  the  year,  in  some  sections  of  the  country. 
This  is  true  in  Canada,  in  certain  parts  of  the  Northwest,  and  in 
the  South.  In  the  circulars  of  bond  houses  offering  timber  bonds 
it  has  been  asserted  that  standing  timber  located  in  the  Southern 
States  has  never  been  destroyed  by  fire.  This  statement  needs 
qualification.  Nevertheless,  it  is  true  that  any  serious  damage 
by  fire  in  the  Southern  pine  belt  is  very  unlikely,  if  not  impossible, 
because  of  the  absence  of  underbrush  and  low-growing  branches. 
Thirdly,  even  when  fire  kills  the  green  standing  stock,  that  stock 
is  not  necessarily  lost.  Most  of  it  may  be  saved  by  cutting  within 
a  season   or  two. 

1181.  The  trustee  will  at  least  see  that  every  insurable  risk, 
such  as  the  mills  and  equipment,  is  protected  by  insurance. 

Derived  Products 


Pine:  yellow. 


Average 

priceper 

M  feet. 


Rela- 
tive 
price. 


Spruce. 


Average 
priceper 
M  feet. 


Rela- 
tive 
price. 


Tar. 


Average 

priceper 

barrel 


Rela- 
tive 
price. 


Turpentine : 
spirits  of. 


Average 

priceper 

gallon. 


Rela- 
tive 
price. 


YEAR. 


$18.4646 
20.7500 
19.9583 
18.5000 
18.5000 
18.5000 
16.9167 
16.4167 
16.4375 
18.6250 
20.0417 
20.7083 
19.6667 
21 .0000 
21.0000 
21.4167 
24.9167 
29.3333 
30.5500 
30.5500 


100.0 

$14.3489 

112.4 

16.2917 

108.1 

14.2183 

100.2 

14.8542 

100.2 

13.7708 

100.2 

12.7083 

91.6 

14.2500 

88.9 

14  2500 

89.0 

14.0000 

100.9 

13  7500 

108.5 

15.3958 

112.2 

17.3750 

106.5 

18.0000 

113.7 

19.2500 

113.7 

19.1875 

116.0 

20.5000 

134.9 

21.4167 

158.9 

25.5417 

165.2 

24.0000 

165.2 

20.7917 

100.0 

113.5 

99.1 

103.5 

96.0 

88.6 

99.3 

99.3 

97.6 

95  8 

107.3 

121.1 

125.4 

134.2 

133.7 

142.9 

149.3 

178.0 

167.3 

144.9 


$1.2048 
1.4750 
1.5833 
1.3000 
1.0458 
1.0917 
1.1417 
1.0125 
1.0542 
1.0979 
1.2458 
1.3625 
1.2817 
1.3250 
1 .6792 
1.6792 
1.7583 
1.9583 
2.3292 
1.6000 


100.0 

122.4 

131.4 

107.9 

86.8 

90.6 

94.8 

84.0 

87.5 

91.1 

103.4 

113.1 

106.4 

110.0 

139.4 

139.4 

145.9 

162.5 

193.3 

132.8 


1.3343 
.4080 
.3795 
.3227 
.3002 
.2932 
.2923 
.2743 
.2924 
.3221 
.4581 
.4771 
.3729 
.4740 
.5715 
.5757 
.6276 
.6649 
.6344 
.4533 


100.0 

Average, 
1890-1899 

122.0 

1890 

113.5 

1891 

96.5 

1892 

89.8 

1893 

87.7 

1894 

87.4 

1895 

82.1 

1896 

87.5 

1897 

96.4 

1898 

137.0 

1899 

142.7 

1900 

111.5 

.1901 

141.8 

1902 

171.0 

1903 

172.2 

1904 

187.7 
198.9 
189.8 

1907 

135.6 

1908 

3S2  TIMBER  BONDS 

1182.  The  principle  of  the  distribution  of  risk  can  be  applied 
to  timber  tracts,  and  sometimes  is.  There  are  vast  timber  limits 
in  the  eastern  provinces  of  Canada,  under  one  control,  that  are 
separated, — dove-tailed  as  it  were, — by  strips  in  other  ownership; 
but  I  here  are  patent  transportation  disadvantages  under  this  ar- 
rangement, unless  the  several  properties  are  united  by  a  drivable 
stream,  that  the  logs  may  advantageously  be  sent  to  mill  or  market. 
Large  tracts  surrounded  by  alien  property  are  generally  operated 
separately. 

1183.  Amortization.  In  common  with  concerns  operating  in  any 
kind  of  fields  of  deposit,  such  as  coal  and  metal  mines,  so  that  the 
income  is  derived  at  the  expense  of  the  assets,  lumber  companies 
should  arrange  the  maturities  of  their  loans  in  regular  series,  pre- 
sumably annual.  The  mortgage  should  contain  carefully  detailed 
provision  by  which  the  retirement  of  the  loan  will  be  at  faster  rate 
than  the  depletion  of  the  assets.  There  can  be  no  fixed  tax  for 
the  sinking  fund  which  shall  be  standard.  A  common  and  often 
safe  amount  is  $3  per  thousand  feet,  log  scale,  of  standing  timber; 
but  the  rate  will  be  determined  by  the  value  of  the  timber.  It  may 
be  stipulated  that  periodic  sworn  statements  of  the  amount  cut 
be  made  by  the  superintendent  of  the  cutting,  and  verified  by  the 
principal  officers  of  the  company.  It  is  best  to  have  a  minimum 
annual  instalment  to  meet  the  requirements  of  redemption,  and  to 
increase  the  equity  annually. 

1184.  This  redemption  fund  will  apply  to  the  payment  of  the 
principal  only,  and  will  be  on  the  basis  of  about  double  the  amount 
for  which  the  timber  is  mortgaged,  and  will  operate  to  retire  all 
of  the  bonds  before  consuming  over  one-half  the  timber. 

1185.  The  sequestration,  for  the  sinking  fund,  of  a  specified  sum 
per  annum  is  not  as  satisfactory  as  the  scale  method  with  a  mini- 
mum attached,  for  if  a  fire  should  sweep  through  and  kill  a  large 
part  of  the  timber,  it  would  be  necessary  to  cut  down  the  dead 
stumpage  within  a  year  or  two,  and  the  sinking  fund  should  be 
protected  accordingly. 

1186.  If,  because  of  the  amount  cut,  the  deposits  under  the  re- 
demption fund  should  exceed  the  amount  of  bonds  maturing  in  any 
year,  the  trustee  should  be  obliged  to  purchase,  or  call  for  redemp- 
tion at  some  small  premium,  such  as  3  per  cent,  and  interest,  the 
unmatured  bonds  in  amount  sufficient  to  exhaust  the  surplus. 

1187.  Sometimes  a  limber  land  bond  is  the  issue  of  a  company 
doing  business  in  a  specialty  such  as  cooperage.    The  sinking  fund 


TIMBER  BONDS  383 

then  may  be  gauged  in  terms  of  the  product: — for  instance,  in 
cooperage,  of  perhaps  $5  a  cord  of  bolts  for  staves  and  headings. 
In  such  case  the  circular  should  translate  into  terms  of  feet,  that 
the  bond  buyer  may  estimate  the  equity  and  the  rate  of  redemption. 
It  should  be  provided  in  the  mortgage  that  a  large  part  of,  if  not 
all,  the  sums  obtained  by  sale  of  timber  to  other  companies  should 
be  applied  to  the  redemption  of  bonds.  Bond  buyers  are  more 
likely  to  meet  a  cord  charge  on  pulp  wood,  for  paper  company 
bonds  are  more  numerous. 

1188.  Management,  History,  and  Earnings.  The  personnel  and 
financial  standing  of  owners  and  managers  are  generally  ascertain- 
able through  the  commercial  agencies.  The  lumber  business  in 
this  country  has  credit  agencies  of  its  own.  A  company's  stock 
is  seldom  widely  distributed,  and  the  reported  standing  of  its  prin- 
cipal owners,  and  the  credit  of  the  company  itself,  may  be  verified 
by  application  to  local  banks.  Additional  light  may  be  thrown  on 
these  matters  by  testimony  from  banks  and  notebrokers  as  to  the 
salability  of  the  company's  unsecured  paper. 

1189.  The  experience  and  success  of  the  company's  members  in 
other  lumber  enterprises  will  have  necessary  bearing;  and  their 
affiliation,  through  stock-ownership  or  otherwise,  with  companies 
that  are  an  outlet  for  their  product. 

1190.  The  paid-up  capital,  the  surplus,  and  if  the  company  is 
established,  the  net  earnings  for  the  past  five  years,  the  relation  of 
net  earnings  to  gross,  etc. — all  will  be  subjects  for  examination. 

1191.  Marketability  and  Income.  Timber  land  bonds  usually  bear 
6  per  cent,  interest,  and  are  sold  at  par  or  thereabout.  In  spite  of 
its  excellences  (providing  danger  from  serious  fire  is  remote), 
this  type  of  loan  is  too  new,  and  its  acceptance  as  investment  too 
limited,  for  the  purchaser  to  expect  a  ready  market.  If  the  issue 
bas  been  outstanding  for  some  time  the  trustee  may  be  interested 
in  an  offer  for  the  sinking  fund.  But  the  buyer's  main  recourse  is 
the  bond  house  of  which  he  bought.  Hence  its  attitude  in  regard 
to  repurchasing  its  specialties  is  of  utmost  interest  to  him. 


CHAPTER  XXXI 
RECLAMATION  ISSUES:  IRRIGATION  DISTRICT  BONDS 

1192.  One  does  not  often  meet  with  the  expression  Reclamation 
Issues  in  the  nomenclature  of  finance.  Yet  there  is  a  type  of  obli- 
gations, with  sharply  defined  common  characteristics,  that  may 
well  bear  this  title,  if  only  for  convenience  of  designation  in  the 
discussion  of  fiscal  theories.  In  its  three  subdivisions,  Irrigation, 
Drainage,  and  Levee  Bonds,  it  represents  the  financial  means  by 
which  formerly  unproductive  territory  in  the  United  States,  equal 
in  extent  to  several  per  cent,  of  the  total  area,  is  working  out  its 
own  salvation.  This  broad  use  of  the  word  reclamation  is  thor- 
oughly justified  by  its  meaning  and  by  its  employment  in  Con- 
gressional acts.  In  Western  law  it  is  used  more  particularly  of  the 
work  of  drainage  and  of  levee  building. 

1193.  Nature  has  dealt  more  kindly  with  us  than  we  knew  a 
generation  ago.  A  comparatively  small  proportion  of  our  immense 
lowland  country  is  irredeemable  desert.  Latterly  we  have  come 
to  realize  that  the  alchemy  of  modern  engineering  can  easily  con- 
vert wastes  of  sage  brush  or  marsh  grass  into  ultimate  gold.  Noth- 
ing is  needed  but  skill  to  lead  down  waters  to  the  plains,  or  may 
be  to  drive  them  back  from  the  soil ;  for  all  reclamation  of  land 
is  concerned  with  water,  which  gives  life  to  vegetation  here  and 
takes  it  away  there.  Or  rather  skill  is  not  needed, — we  have  that, — 
but  the  sense  of  community  of  interest,  which  under  Government 
leadership  and  help  has  done  so  much  already  for  lands  in  Western 
States. 

1194.  Reclamation,  then,  is  of  two  general  kinds:  irrigation  and 
drainage.  The  work  of  irrigation  is  more  spectacular  and  on 
larger  scale;  indeed  it  is  the  more  important.  Up  to  this  time  it 
has  received  from  the  Government  more  attention,  both  depart- 
mental and  legislative.  But  the  day  is  near  at  hand  when  drainage 
problems,  especially  in  the  East  where  they  have  been  neglected, 
will  be  given  their  due  consideration  and  will  be  solved  financially, 
as  we  shall  see,  along  lines  laid  out  in  irrigation  development. 
It  seems  proper,  therefore,  to  group  these  kindred  securities. 

384 


RECLAMATION  ISSUES  385 

Irrigation  Bonds 

1195.  One  of  the  several  classes  of  securities  that  have  not  as 
yet  attained  a  general  recognition  in  the  East  is  the  Irrigation 
Bond.  Although  irrigation  itself,  successful  and  colossal,  is  as 
old  as  Egypt  and  Babylon,  and  had  made  green  the  Aztec  soil  of 
America  before  the  coming  of  Europeans,  and  is  now  destined  to 
nourish  the  waste  places  of  more  than  a  dozen  states  and  territories, 
the  bonds  of  its  financing,  even  under  present-day  conditions,  are 
looked  at  askance  by  Eastern  investors,  who  are  prone  to  asso- 
ciate them  with  the  old  Western  farm  mortgages  to  which  they  bear 
little  likeness,  except  that  they  are  Western  and  yield  a  high  re- 
turn, and  that  there  has  been  sufficient  miscarriage  and  undoing  of 
irrigation  projects  to  warrant  a  critical  attitude  toward  them. 

1196.  Early  Weaknesses.  It  will  be  remembered  that  equipment 
issues  arose  out  of  a  need,  among  the  weaker  railroads,  for  rolling 
stock,  which  they  were  too  poor  to  purchase  out  of  surplus  revenues, 
or  by  means  of  the  usual  funded  loans.  When,  in  the  course  of 
years,  the  expediency  of  equipment-bond  financing  was  demon- 
strated, and  laws  were  enacted  in  most  states  to  protect  the  con- 
tracts that  were  the  basis  of  the  security,  the  custom  of  purchasing 
equipment  by  means  of  special  equipment  issues  became  quite  gen- 
eral ;  and  up  to  nearly  the  present  time,  the  tendency  to  strengthen 
the  security  behind  equipment  bonds,  especially  by  writing  better 
and  more  uniform  trust  deeds,  has  been  continuous.  Just  as,  and  at 
about  the  same  time  that,  ten-year  serial  equipment  bonds  came 
to  be  issued,  irrigation  began  to  be  the  subject  of  serious  study, 
and  an  outlet  for  speculative  activity  in  the  arid  West;  and  the 
growth  of  the  West,  in  population,  in  material  well-being,  in  en- 
gineering skill,  in  agricultural  science,  and  in  law, — especially  in 
irrigation  law, — has  steadily  raised  the  status  of  irrigation,  broad- 
ened its  activities,  and  greatly  strengthened  the  security  for  ten- 
year  serial  irrigation  bonds;  although  it  is  by  no  means  to  be  im- 
plied from  this,  that,  as  a  class,  irrigation  bonds  are  on  anything 
like  the  same  plane  of  security  as  equipment  bonds. 

1197.  There  were  three  main  causes  of  hazard  in  the  irrigation 
enterprises  of  the  early  days:  the  immaturity  of  American  irriga- 
tion engineering,  the  instability  of  Western  business  conditions, 
and  the  confusion  of  law  as  affecting  land  and  water  rights.  The 
first  two  of  these  we  may  dismiss  as  things  largely  of  the  past, 
and  give  attention  to  the  third. 


380  RECLAMATION  ISSUES 

1198.  Land  and  Water  Rights  and  the  Law.  Irrigation,  of  course, 
as  slated,  has  to  do  with  the  union  of  water  and  land  in  the  in- 
teresl  of  fertility.  More  difficulties  of  all  sorts  have  arisen  from 
questions  concerning  the  supply  and  diversion  of  water  than  from 
problems  concerning  the  allotment  and  ownership  of  land.  These 
difficulties,  now  and  in  the  past,  have  been  accentuated  on  the 
Pacific  coast.  Each  of  the  three  immense  states  on  the  Pacific 
slope: — California,  Oregon,  and  Washington, — has  ''both  a  wet  and 
a  dry  end";  i.e.  each  has  a  part  of  its  territory  so  situated  as  to 
be  rain-watered,  and  independent  of  engineering  for  fertility;  and 
a  part  so  situated  that  it  has  no  rainy  season,  and  is  productive 
only  when  artificially  watered.  As  a  result,  there  has  been  a  con- 
stant tendency,  from  the  very  beginning  toward  a  difference  in 
judicial  opinion  as  to  the  rights  of  the  public,  and  of  the  abutters, 
to  streams  of  water. 

1199.  Naturally,  judges  of  courts  having  jurisdiction  in  arid 
territory,  have  construed  state  law  most  favorably  to  the  interests 
of  settlers;  those  in  the  rainy  belt  have  taken  the  more  usual  com- 
mon law  stand  in  regard  to  riparian  rights,  and  (for  illustration) 
have,  to  some  extent,  protected  the  proprietors  of  riparian  land 
from  up-stream  detention,  diversion,  and  pollution  of  water.  This 
conflict  of  the  doctrine  of  appropriation  with  the  older,  world- 
wide doctrine  of  riparian  rights,  has  unsettled  the  status  of  irriga- 
tion bonds  in  California,  Oregon,  and  Washington.  Under  the  in- 
fluence of  permanent  geographical  conditions,  state  law  here  still 
permits  an  undesirable  latitude  of  method  in  the  redemption  of 
unproductive  land.  In  the  three  states  mentioned,  and  in  those 
others  in  which  the  common-law  doctrine  of  riparian  rights  ob- 
tained a  foothold  in  the  early  days  of  their  settlement,  the  doctrine 
of  appropriation  now  prevails  only  where  the  common  law  prin- 
ciple cannot  obtain,  namely  on  waters  belonging  to  the  state  or  to 
the  United  States.  This  is  the  law  established  in  California  by  the 
well-known  case  of  Lux  v.  Haggin  (69  Cal.  255,  10  Pac.  074). 

1200.  There  has  been  no  such  conflict  in  the  more  generally  arid 
states.  The  law  has  been  at  one  with  itself,  and  consequently 
favorable  to  general  and  equitable  reclamation  in  Idaho,  Wyoming, 
Colorado,  and  Nebraska.  At  its  best  it  recognizes  that  water, 
when  appropriated,  "  rises  to  the  dignity  of  a  distinct  usufructuary 
estate  or  right  of  property."  In  some  of  these  states  there  is  not 
a  vestige  of  riparian  rights. 

1201.  Federal   Irrigation.     Fortunately,   the   redemption  of   arid 


IRRIGATION  DISTRICT  BONDS  387 

land  has  not  been  left,  all  this  time,  solely  to  the  initiative  and 
discretion  of  the  commonwealths.  Moved,  no  doubt,  by  the  failure 
of  irrigation  enterprises  in  California  and  elsewhere,  Congress  in 
the  past  20  years  has  freely  discussed  irrigation  and  has  enacted 
several  laws  in  the  interest  of  the  reclamation  of  desert  places  in 
the  United  States.  It  is  only  natural  that  the  line  of  federal 
action  should  be  in  evolution  from  past  governmental  policies  con- 
cerning the  settlement  and  development  of  public  lands,  since 
it  is  public  lands  that  most  need  irrigation.  These  policies  are 
summed  up  in  the  Homestead  Law  of  1872,  and  the  Desert  Land 
Act  of  1877,  amended  in  1891;  but  the  earlier  law  had,  however, 
no  direct  connection  with  irrigation. 

1202.  The  Homestead  Law  gave  title  of  public  land  in  the  extent 
of  160  acres  to  any  citizen  establishing  and  maintaining  residence 
upon  it  and  cultivating  it  for  a  period  of  five  years.  By  amendment 
the  lustrum  was  commuted  to  14  months,  on  payment  of  f  1.25  per 
acre. 

1203.  The  Desert  Land  Act  differed  from  the  Homestead  Law 
in  these  respects: — it  concerned  the  irrigation  and  settlement  of 
desert  land;  and  therefore  it  granted  larger  tracts  to  each  settler, 
namely,  640  acres,  and  title  was  passed  on  the  annual  expenditure 
of  f  1.00  per  acre  for  three  consecutive  years.  By  the  amendment 
of  1891,  320  acres  was  the  maximum  apportionment,  and  the  other 
previous  requirements  were  made  more  stringent. 

1204.  The  National  Irrigation  Act.  Upon  these  as  a  basis,  and 
also  upon  the  Carey  Act,  which  will  be  taken  up  separately,  Con- 
gress passed,  in  1902,  the  National  Irrigation  Act,  under  which  the 
Government  now  conducts  its  operations.1  A  survey  of  this  law 
will  be  helpful  to  a  right  understanding  of  the  principles  by  which 
waste  land  is  redeemed;  but  no  bond  issues  are  put  forth  as  the 
result  of  it.  It  declares  that  the  work  of  reclamation  must  be  paid 
for  by  the  sale  of  the  rights  on  the  specific  lands  benefited ;  and  that 
when  so  paid  for  the  fund  shall  be  returned  to  the  Government, 
and  that  the  purchasers  of  the  water  rights  shall  become  the  owners 
of  the  irrigation  works,  i.e.  dams,  flumes,  canals,  gates,  ditches,  etc., 
and  all  rights  appertaining.  The  water  rights  may  be  paid  for  in 
10  yearly  instalments.  It  declares  that  all  moneys  received  from 
the  sale  of  public  lands  in  certain  (16)  states  and  territories,  shall 
be  set  aside  as  a  special  fund  in  the  Treasury,  known  as  the  rec- 

1  For  the  complete  text  see  32  U.  S.  Statutes  388,  ch.  1093. 


388  RECLAMATION  ISSUES 

lamation  fund,  to  be  used  in  the  examination  of,  and  survey  for, 
and  the  construction  and  maintenance  of  irrigation  works  for  the 
reclamation  of  arid  and  semi-arid  lands  in  the  slates  and  terri- 
tories from  which  the  funds  came.  It  also  empowers  the  Secre- 
tary of  the  Interior  to  withdraw  from  public  entry  the  lands  re- 
quired. 

1205.  When  the  Secretary  determines  that  any  irrigation  project 
submitted  to  him  is  practicable,  he  may  cause  to  be  let  contracts 
for  the  construction,  and  shall  limit  the  area  of  entry  to  what  may 
be  reasonably  required  for  the  support  of  a  family,  also  the  charges 
that  shall  be  made  per  acre  (with  a  view  of  returning  to  the  recla- 
mation fund  the  cost  of  construction),  and  also  the  number  of 
annual  instalments,  not  exceeding  10,  in  which  such  charges  shall 
be  paid. 

1206.  The  entryman  upon  the  irrigated  lands  shall  reclaim  at 
least  one-half  of  the  total  irrigable  area  for  agricultural  purposes, 
and  before  receiving  patent  for  the  lands  covered  by  his  entry,  shall 
pay  the  Government  the  charges  apportioned  against  his  tract. 
No  water  right  shall  be  sold,  for  land  in  private  ownership,  to  a 
tract  exceeding  160  acres,  and  no  such  sale  shall  be  made  to  any 
landowner  unless  he  be  an  actual  bona  fide  resident  on  such  land, 
or  occupant  thereof  residing  in  the  neighborhood. 

1207.  When  the  payments  required  by  this  Act  are  made  for 
the  major  portion  of  the  lands  irrigated,  then  their  management 
and  operation  shall  pass  to  the  owners  of  the  land  irrigated  thereby, 
to  be  maintained  at  their  expense  under  such  form  of  organization 
and  rules  and  regulations  as  may  be  acceptable  to  the  Secretary  of 
the  Interior;  provided  that  the  title  to  and  management  of  reser- 
voirs and  the  works  necessary  to  their  protection  and  operation 
shall  remain  in  the  Government  until  otherwise  provided  by  Con- 
gress. 

1208.  Present-Day  Irrigation  Under  State  Law.  By  federal  irriga- 
tion is  meant  the  redemption  of  public  lands  of  the  United  States, 
under  the  guidance  and  restriction  of  federal  law  as  embodied  in 
the  National  Irrigation  Act,  which  we  have  just  considered.  On 
fulfilment  of  the  conditions,  title  to  the  reclaimed  land  is  passed 
from  the  Government  to  the  settler,  who,  of  course,  is  acting  under 
state  law  as  well. 

In  the  present  topic,  "  Irrigation  under  State  Law,"  we  come  to 
those  reclamation  operations,  in  some  of  which  the  National  Gov- 
ernment does  not  appear  at  all;  and  in  others,  it  appears  at  least 


IRRIGATION  DISTRICT  BONDS  389 

at  one  remove  from  contact  with  the  settler.  Title  to  the  land  to 
be  reclaimed,  until  transfer,  is  in  individuals  or  private  corpora- 
tions, or  else  in  the  state;  but  not  in  the  National  Government. 
The  operations  are  usually  financed  by  the  sale  of  bonds. 

1209.  It  is  these  projects,  therefore,  that  interest  us  most;  and 
in  order  to  get  a  correct  idea  of  the  bonds  they  produce,  it  will  be 
well  to  classify  them.  They  may  be  "  Irrigation  District "  projects, 
"Carey  Act"  projects,  or  "  Private  Company"  projects; — each 
having  its  distinctive  advantages  and  drawbacks  as  security  for 
capital. 

Irrigation  District  Bonds 

1210.  Irrigation  District  Bonds.  In  the  chapter  entitled  The  Bonds 
of  Tax  Districts  it  was  explained  that  many  municipal  cor- 
porations were  organized  with  hardly  a  thought  for  general  admin- 
istrative or  governmental  functions,  but  for  the  purpose  of  levying 
special  taxes  to  provide  funds  for  objects  of  pecuniary  value  to  the 
lands  thus  taxed;  and  that  since  these  lands  were  not  coincident 
with  any  more  strictly  governmental  municipal  corporations,  such 
as  town  or  county,  the  bonds  of  these  districts  had  come  to  be 
called  "  Taxing  District  Bonds,"  or  for  brevity,  "  District  Bonds." 
Irrigation  District  Bonds  were  there  cited  in  illustration.  To 
these  issues,  the  principles  that  govern  district  bonds  in  general 
are  applicable ;  and  although  irrigation  districts  may  not  always  be 
looked  upon  as  municipal  corporations,  the  Bonds  are  legitimately 
classified  under  Municipals,  and  are  quite  distinct,  as  a  form  of 
security,  from  Carey  Act  or  Private  Project  issues. 

1211.  The  question  immediately  arises,  since  the  validity  of  mu- 
nicipal issues  is  so  often  open  to  question,  what  bearing  has  the 
doubtful  standing  of  the  irrigation  district,  as  a  municipal  corpora- 
tion proper,  upon  the  validity  of  irrigation  district  bonds.  Such  a 
district  is  at  least  a  public  corporation,  for  its  officials,  administra- 
tion, and  functions  are  all  public ;  and,  "  being  a  public  corporation, 
the  validity  of  its  organization  cannot  be  collaterally  attacked,  as 
in  a  suit  to  enjoin  the  sale  of  lands  for  assessments,  by  showing 
that  the  board  of  supervisors  acted  without  their  jurisdiction  in 
effecting  the  organization  of  the  district.  So,  also,  the  irrigation 
district  cannot  plead  the  illegality  of  its  own  organization  as  a 
defense  to  an  action  on  bonds  issued  by  it  ;"  x  but  on  the  other 

1  Long  on  Tlie  Law  of  Irrigation  Bondt. 


300  RECLAMATION    ISSUES 

hand  it  may  seek  confirmation  of  the  legality  of  its  proceedings,  by 

submitting  itself,  either  on  petition  of  the  hoard  of  supervisors  of 
the  district,  or  of  an  assessment  payer,  to  the  superior  court  of  the 
countv  in  which  its  acreage  chiefly  lies. 

1212.  There  is  considerable  difference  of  attitude  in  the  arid  and 
semi-arid  states  toward  the  three  modes  of  irrigation.  California, 
Idaho,  Kansas,  Nebraska.  Nevada,  and  Washington  have  all  had 
considerable  experience  in  municipal  irrigation,  and  a  more  or  less 
common  body  of  municipal  irrigation  district  laws.  Colorado,  also, 
is  given  to  the  prosecution  of  her  works  along  strictly  municipal 
lines.  Bonds  there  are  issued  by  permission  of  the  General  Assem- 
bly, and  authorized  by  the  qualified  electors  of  the  district  benefited, 
and  their  legality  is  passed  on  by  the  district  court.  In  many  re- 
spects they  are  of  the  nature  of  school  district  loans.  County  com- 
missioners fix  the  rate  of  tax  levy  for  the  district  in  excess  of  re- 
quirements for  interest  and  maintenance  charges.  The  County 
Treasurer  is  ex-officio  treasurer  of  the  irrigation  district  and  levies 
taxes  in  the  same  manner  and  at  the  same  time  as  the  regular 
taxes  on  realty  and  personalty  for  county  purposes;  but  there  is 
this  to  the  advantage  of  municipal  irrigation  issues,  that  they, 
unlike  most  school  district  issues,  are  usually  obligations  on  the 
district  prior  to  any  subsequently  imposed. 

1213.  One  is  not  to  infer  from  this,  however,  that  the  political 
origin  of  municipal  irrigation  issues  gives  a  signal  advantage  over 
the  issues  of  the  Carey  Act  or  Private  Projects.  Irrigation  dis- 
tricts, in  the  nature  of  the  case,  are  formed  more  strictly  for  in- 
dustrial, or  rather,  for  agricultural  purposes,  than  are  most  dis- 
tricts. School  and  water  districts  may  be  part  of,  or  include  great 
cities;  they  may  have  corporate  assets  of  great  value,  apart  from 
any  consideration  of  the  assessable  values  of  the  property  in  the  dis- 
trict; and  their  municipal  plants  may  sometimes  be  productive  of 
revenues  even  in  excess  of  the  interest  and  sinking-fund  charges 
on  their  funded  debts.  But  irrigation  districts  are  not  formed 
except  when  the  lands  that  compose  them  are  in  need  of  greater 
fertility;  and  it  is  not  likely  that  lands  will  be  included  in  the 
district,  and  be  subjected  to  its  comparatively  high  tax,  unless 
they  are  greatly  to  benefit  by  it.  Irrigation  districts,  therefore,  are 
usually  "  rural  districts  "  and  subject,  as  respects  security,  to  the 
limitations  that  usually  attend  "  rural  "  political  divisions,  as  con- 
trasted with  "  municipal  "  or  "  city  "  divisions.  They  suffer  by 
comparison,  as  to  the  personnel  of  the  administration,  the  provi* 


IRRIGATION  DISTRICT  BONDS  391 

dence  and  continuity  of  their  fiscal  policies,  and  the  general 
esprit  du  corps.  They  are,  therefore,  peculiarly  susceptible  to  the 
temptation  to  repudiate  their  obligations. 

1214.  Irrigation  districts  are  not  only  rural,  rather  than  munici- 
pal, but  they  may  be  even  arid  at  the  time  of  their  formation.  In  this 
event  the  security  for  the  bonds  would  depend,  as  it  does  in  Carey 
Act  projects,  almost  entirely  on  the  successful  outcome  of  the  irri- 
gation enterprise.  It  is  not  to  be  expected  that  rightly  conducted 
districts  will  suffer,  in  the  future,  through  engineering  miscalcula- 
tion; but  as  rural  divisions,  formed  for  an  industrial  undertaking, 
they  may  be  sensitive  to  the  influence  of  general  business  conditions. 
This  is  the  conclusion  of  an  inquiry  into  the  history  of  irrigation 
districts,  from  their  origin  in  the  passage  of  the  Wright  Act  of  1887, 
in  California.1 

1  Since  these  paragraphs  were  written  there  have  been  a  dozen  defaults  on  irriga- 
tion issues  that  have  come  to  notice,  among  them  several  municipal  district  issues, 
principally  in  Colorado. 


CHAPTER  XXXII 

RECLAMATION  ISSUES:  PRIVATE  PROJECT  AND  CAREY 

ACT  BONDS 

1215.  Strictly  speaking,  all  irrigation  projects  that  are  not 
furthered  by  municipal  corporations,  are  "  private  projects ;"  but, 
"  Carey  Act  projects  "  are  so  distinctly  set  apart  from  other  private 
irrigation  enterprises,  in  that  their  aim  is  to  reclaim  public  land, 
and  in  that  they  are  the  result  of  governmental  aid  and  direction, 
it  is  customary  to  exclude  them  from  this  division.  Private  irriga- 
tion projects,  then,  we  shall  define  as  those  undertaken  by  in- 
dividuals or  private  corporations  to  improve,  by  watering,  under 
state  law,  lands  in  private  ownership. 

Private  Projects 

1216.  Factors  Making  for  Security.  The  value  of  the  bonds  issued 
by  private  irrigation  companies  is  usually  determined  by  the 
following  factors: 

1st.  The  existence  of  an  adequate  and  permanent  water  supply. 

2nd.  The  title  to  the  water  supply  in  the  company  claiming  it. 

3rd.  The  character  and  value  of  the  irrigated  land. 

4th.  The  title  to  the  land. 

5th.  The  character  of  the  settler. 

1217.  The  Water  Supply.  It  might  sometimes  happen  in  private 
developments,  for  instance  in  the  semi-humid  valley  section  of 
Eastern  Washington,  that  irrigation  bonds  would  have  some  se- 
curity in  the  land-mortgage,  even  should  water  for  irrigation  utterly 
fail,  for  one  cause  or  another;  and  in  private  projects  generally, 
the  land  values,  potentially  greater  than  in  Carey  projects,  offer 
some  degree  of  security  as  in  simple  real  estate  mortgages.  But 
as  a  broad  statement,  it  is  fair  to  say  that  the  security  for  irriga- 
tion bonds  is  almost  as  dependent  on  an  adequate  and  permanent 
supply  of  water  as  is  the  security  for  the  bonds  of  hydro-electric 
power  companies. 

1218.  However,  the  sources  of  this  supply  for  irrigation  are 
more  general  than  for  power  developments,  since  power  itself  is 


PRIVATE  PROJECT  AND  CAREY  ACT  BONDS        393 

not  requisite,  but  merely  water.  Some  large  irrigation  undertak- 
ings are  upon  plateaus,  and  pump  their  water  from  rivers  flowing 
at  a  lower  level ;  or  even,  in  want  of  water  courses,  pump  their 
water  from  artesian  wells.  Questions  of  minimum  flow  or  supply, 
past  or  prospective,  due  to  deforestation,  drought,  and  mechanical 
obstruction  and  diversion, — all  enter  into  the  security  offered  by 
water  supply. 

1219.  The  Water  Title  and  the  Water  Rights.  Questions  of  me- 
chanical obstruction  and  diversion  lead  immediately  to  the  subject 
of  water  rights,  already  discussed.  One  source  of  Eastern  miscon- 
ception of  irrigation  issues  lies  in  this  unfamiliarity  with  the 
"  usufructuary  estate  "  of  water  as  developed  in  the  laws  of  the 
arid  commonwealths.  Title  to  water  supply,  in  these  states,  means 
title  to  "  reasonable  use,"  i.e.  the  right  of  a  proprietor  to  divert 
his  due  portion  of  water,  which  shall  not  be  diminished  by  any 
subsequent  grant,  to  an  adjacent  proprietor,  of  right  to  withdraw 
water  from  the  same  stream. 

1220.  It  very  occasionally  happens  that  bonds  are  issued  against 
a  lien  on  the  works  and  water  rights  alone.  Unless  the  circum- 
stances were  unusual,  these  bonds  are  not  to  be  commended.  The 
better,  ordinary  irrigation  bond  represents  a  first  mortgage  on  the 
land  of  the  issuing  company,  to  which  land  adequate  water  rights 
attach.  Sometimes  two  companies  are  organized,  one  to  build 
and  own  the  water  rights,  and  the  other  to  own  the  land  to  be 
subdivided,  watered,  and  sold  to  settlers.  In  this  case  the  irriga- 
tion company  (the  company  owning  the  works  and  water  rights), 
issues  to  the  land  company  certificates  of  water  rights,  legally 
describing  the  land  which  the  water  is  to  cover,  and  also  guaran- 
teeing the  bonds,  so  that,  in  effect,  the  bonds  are  secured  by  a  lien 
both  on  land  and  on  water  rights.  This  double  security  must 
always  be  looked  for  since  the  funded  credits  of  irrigation  enter- 
prises represent  in  finance  what  the  physical  elements  do  in  irriga- 
tion :  a  union  of  water  and  land,  so  that  the  water  becomes  appur- 
tenant and  inseparable. 

1221.  The  Watered  Land.  Another  source  of  Eastern  misconcep- 
tion is  due  to  ignorance  of  Western  land  qualities  and  land  values. 
The  arid  tracts  that  await  watering  are  not  usually  poor  lands  in 
want  of  enrichment,  but  rich  lands  in  want  of  moisture.  To  great 
depths  they  are  full  of  soluble  salts,  chemically  stimulating,  that 
have  not  been  washed  away  by  the  rains  of  humid  climes,  and  that, 
when  wet,  will  draw  down  great  deep  roots  of  vegetation,  and  sus- 


394  RECLAMATION  ISSUES 

taill  thorn  with  vitality  through  a  long  period  of  drought.  In 
such  soil  crop-rotation  and  surface-fertilization  will  long  be  un- 
necessary. 

1222.  The  values  of  lands  like  these,  when  irrigated,  multiply 
by  leaps  and  bounds  beyond  all  precedent  in  other  forms  of  stable 
realty.  The  Chief  Engineer  of  the  Government  Reclamation  Serv- 
ice says :  "  The  open  range  of  the  arid  region  is  capable  of  support- 
ing one  cow  to  every  20  or  30  acres;  the  same  land  when  watered 
and  put  to  alfalfa  will  feed  12  cows  to  every  20  acres,  or  in  orchard, 
in  favorable  altitudes,  will  support  a  family  of  from  three  to  five 
persons.  An  enormous  enhancement  in  land  values,  therefore,  at- 
taches to  the  reclamation  of  these  arid  tracts.  As  an  open  range  its 
value  may  be  50  cents  per  acre;  while  under  irrigation  the  selling 
price  may  be  from  $50  to  $1,000  per  acre." 

1223.  The  Land  Title.  It  is  in  the  matter  of  land  values  that 
bonds  of  the  class  described  may  have  advantage  over  Carey  Act 
bonds,  in  that  the  lands  available  for  private  irrigation  must  be 
those  in  which  title  has  passed  from  the  Government  or  the 
state,  and  is  held  by  individuals  or  corporations.  In  the  West, 
lands  of  any  considerable  area,  that  have  the  title  in  this  condi- 
tion, are  almost  universally  in  a  well-established  country,  with 
established  values,  and  in  proximity  to  towns  and  transportation. 
Since  the  fee  titles  to  these  lands  are  fixed  directly  in  the  corpora- 
tion, the  lands  are  usually  sold  and  resold,  and  settled  upon  and 
improved,  from  the  time  irrigation  is  started;  and  since  the  price 
of  these  lands  is  being  determined  by  a  free  market,  not  only  are 
the  values  of  the  lands  established,  but  they  are  current  also. 

1224.  The  Scale  of  Private  Projects.  That  private  irrigation 
projects  are  usually  much  smaller  than  Carey  Act  projects  operates 
somewhat  against  economies  of  construction;  but  in  these  projects 
the  fact  is  not  always  to  be  deprecated,  since  the  smaller  the  irri- 
gable land  the  briefer  the  period  that  should  be  necessary  for  set- 
tlement, and  the  lighter  the  consequent  charge  against  the  works 
for  interest  and  maintenance  during  the  non-productive  period. 
Because  of  their  freedom  from  government  supervision  private 
projects  require  more  careful  scrutiny  from  investors.  But  if  the 
supply  of  water,  and  the  title  thereto,  and  the  quality  of  the  land, 
are  satisfactory,  and  if  the  lands  are  salable  at  the  price  the 
irrigation  company  ask,  and  if  the  early  interest  and  maintenance 
charges  are  provided  for,  and  the  construction  cost  is  not  too 
greatly  overbonded,  and  the  character  of  the  settlers  is  satisfactory, 


PRIVATE  PROJECT  AND  CAREY  ACT  BONDS        395 

private  projects  have  conformed  to  the  Carey  Act  standard,  and  are 
worthy  of  study  for  certain  kinds  of  investment.  But  the  fore- 
going are  numerous  and  indispensable  provisos. 

Carey  Act  Projects 

1225  The  legislatures  oi  ^ome  states,  like  Wyoming  and  Idaho, 
especially  encourage  the  reclamation  of  segregated  lands  under 
the  provisions  of  the  Carey  Act.  This  comprehensive  and  benefi- 
cent bill,  passed  by  Congress  in  its  primitive  form  in  1894,  was 
named  from  the  Wyoming  senator  who  introduced  it,  and  in  his 
own  state  first  made  use  of  it.  It  authorized  the  Secretary  of  the 
Interior,  with  the  approval  of  the  President,  to  contract  and  agree 
to  patent  to  the  states  of  Washington,  Oregon,  California,  Nevada, 
Idaho,  Montana,  Wyoming,  Colorado,  North  Dakota,  South  Dakota, 
and  Utah,  or  any  other  state  in  which  are  desert  lands,  an  amount 
of  these  lands  not  to  exceed  one  million  acres  to  each  state,  to  aid 
them  in  the  reclamation,  settlement,  cultivation,  and  sale,  in  small 
tracts  to  actual  settlers  of  the  land  in  question. 

A  supplementary  act  of  1896  further  authorized  the  creation, 
by  the  state,  of  liens  against  the  legal  subdivisions  of  the  land 
reclaimed  "  for  the  actual  cost  and  necessary  expenses  of  reclama- 
tion and  reasonable  interest  thereon  from  the  date  of  reclamation 
until  disposed  of  to  actual  settlers;  and  when  an  ample  supply 
of  water  is  actually  furnished  in  a  substantial  ditch  or  canal,  or 
by  artesian  wells  or  reservoirs,  to  reclaim  a  particular  tract  or 
tracts  of  such  lands,  then  patents  shall  issue  to  the  state  without 
regard  to  settlement  or  cultivation." 

1226.  Under  the  amended  Carey  Act  the  typical  mode  of  pro- 
cedure for  irrigation  projects  is  this: — A  proposal,  with  maps, 
plans,  estimates,  etc.,  to  withdraw  certain  lands  from  the  public 
domain  for  the  purpose  of  reclamation,  is  filed  with  the  proper 
authorities.  The  proposal  must  obtain  the  recommendation  of  the 
State  Engineer,  the  approval  of  the  State  Board  of  Land  Commis- 
sioners, the  consent  of  the  Secretary  of  the  Interior,  and  of  the 
President.  The  lands  are  then  withdrawn  from  the  jurisdiction 
exercised  over  the  public  domain,  and  are  subject  to  contract  be- 
tween the  state  and  the  construction  company  for  irrigation  pur- 
poses, according  to  the  state  law  and  the  provisions  of  the  Carey 
Act. 

1227.  Under  the  terms  of  this  contract  the  state  authorizes  a 
prior  lien  on  the  segregated  lands  in  favor  of  the  company,  and  by 


396  RECLAMATION  ISSUES 

the  provisions  of  the  lien,  the  title  to  the  mortgaged  land  is  not 
released  by  the  state  to  the  purchaser  until  he  has  paid  the  com- 
pany for  the  rights  or  shares  in  a  sufficient  amount  of  water  to 
irrigate  his  land.  Furthermore,  title  does  not  pass  from  the  state 
until  the  settlement  is  an  accomplished  fact;  but  the  settler  is  re- 
quired to  have  his  land  under  cultivation  within  a  reasonably 
brief  time  after  the  introduction  of  water.  At  no  time  is  the  title 
vested  in  the  construction  company.  Thus  the  security  for  the 
irrigation  bonds  issued  against  the  company's  prior  lien  is  created 
by  immediate  irrigation,  settlement,  and  cultivation,  in  small  tracts, 
by  home-makers,  acting  under  an  agreement  which  is  effectual  be- 
cause its  infringement  estops  ultimate  transfer  of  title. 

1228.  Since  both  the  financial  and  physical  principles  of  Carey 
Act  projects  are  similar  to  those  of  private  projects,  the  elements 
of  security  for  the  bonds  are  the  same,  and  therefore  are  discussed 
in  the  same  order. 

1229.  The  Water  Supply.  It  is  particularly  in  the  sufficiency 
and  permanency  of  the  water  supply  that  Carey  Act  bonds  have  a 
security  nominally  stronger  than  that  for  municipal  or  private  irri- 
gation bonds.  It  is  much  easier  to  obtain  competent  opinion  on 
one's  land  than  on  one's  water.  But  as  respects  engineering,  a  plan 
ought  to  merit  confidence  that  obtains  the  careful  examination 
and  approval  of  a  State  Engineer  (who  is  presumed  to  be  dis- 
interested), and  of  the  State  Land  Board,  and  of  the  Secretary  of 
the  Interior,  who  has  access  through  the  Government  Reclamation 
Service  to  independent  information  concerning  the  project,  if  he 
should  desire  it.  It  is  well  known  among  the  irrigation  fraternity 
that  the  State  Engineers  take  their  supervisory  duties  very  seriously. 
The  financing  of  the  project  is  quite  another  matter;  there  are 
times  when  it  is  very  hard  to  sell  any  sort  of  land,  and  the  lands 
must  be  readily  salable  if  success  is  to  come.  But  irrigation  en- 
gineering itself,  luiving  now  reached  maturity,  is  not  a  subject  for 
distrust.  If,  then,  in  the  investigation  of  water  supply,  and  in  the 
building  of  water  works,  competency  can  be  assured  at  all,  it  is 
by  the  Carey  method. 

1230.  The  Water  Title  and  the  Water  Rights.  In  Carey  Act 
projects  the  water  rights  assume  even  greater  importance  than  in 
municipal  or  private  projects,  because  of  the  comparative  worth- 
lessness  of  arid  public  land  without  them.  Furthermore,  Carey  Act 
construction  companies  have  no  land  to  sell  or  to  give  title  to, 
since  title  to  these  lands  is  in  the  state.    Therefore,  the  company 


PRIVATE  PROJECT  AND  CAREY  ACT  BONDS         397 

must  seek  its  profits  from  the  sale  of  water  rights  that  are  appur- 
tenant to,  and  inseparable  from  the  land  titles.  But  even  the 
maximum  price  of  these  water  rights  must  be  fixed  by  the  state, 
through  the  State  Engineer,  after  an  examination  of  the  work 
and  an  estimate  of  its  cost.  The  wording  of  the  Carey  Act  seems 
to  allow  the  company  no  profit  for  building  the  works,  but  of 
course  in  those  states  in  which  the  Carey  Act  has  had  its  greatest 
success,  the  authorities  have  allowed  the  construction  company 
a  generous  profit,  by  accepting  very  liberal  estimates  of  the  cost 
of  the  work.  Yet  even  then,  since  the  maximum  charge  is  set 
by  the  state,  it  is  difficult  to  see  how  the  capitalization  of  water 
rights  through  the  bonds  can  be  on  a  very  inflated  basis.  The 
prices  of  the  rights  are  from  $25  to  $45  per  acre.  A  comparison 
of  these  prices  with  the  prices  of  arid  land,  before  and  after 
irrigation,  will  remove  any  skepticism  on  the  score  of  bonded 
over-capitalization  of  water  rights.  The  water  rights  are  pur- 
chased by  the  settler  usually  at  the  rate  of  $1250  of  rights  to 
$1000  of  first  lien.  The  terms  are  a  part  cash  down  and  the  re- 
mainder in  equal  annual  instalments,  for  which  the  settler  gives 
his  promissory  note  secured  by  the  lien,  which  is  virtually  a 
purchase-money  mortgage. 

1231.  The  validity  of  water  titles  can  hardly  come  into  ques- 
tion in  undertakings  so  closely  identified  with  the  state  as  these 
of  the  Carey  Act. 

1232.  The  Watered  Land.  Carey  Act  bonds  are  not  only  a  lien 
on  the  water  rights,  but  also  on  the  land.  The  land-lien  would  be 
worth  little  did  not  the  land  face  irrigation  and  cultivation. 
Until  it  is  sold  and  settled  (and  by  the  terms  it  must  be  settled 
shortly  after  being  sold),  the  project  has  the  burden  of  carry- 
ing charges.  But  Carey  Act  projects  offer  land  bargains,  and  are 
therefore  very  salable  in  spite  of  the  fact  that  they  are  generally 
at  considerable  remove  from  centers  of  population.  They  are  bar- 
gains because  the  land  is  almost  always  first  class  in  quality,  and 
because  the  state  is  donated  the  land  by  the  Federal  Government, 
and  can  therefore  offer  it  to  the  settler  at  50  cents  per  acre. 

1233.  The  land  Title.  The  titles  to  Carey  lands  are  always 
held  by  the  state  when  the  bonds  are  put  on  sale,  having  been 
obtained  from  the  National  Government  at  a  certain  stage  of  the 
development;  and  the  title  is  passed  to  the  settler  at  a  future 
date,  when  he  has  paid  the  price  of  the  water  rights,  and  of  the 
small  sum  asked  for  the   land. 


398  RECLAMATION  ISSUES 

1234.  Since  the  land  titles  come  to  the  state  directly  from  the 
Government,  and  are  later  passed  by  the  slate  directly  to  the  settler, 
they  are  impeccable.  They  could  not  be  clearer  or  less  disputable. 
From  experience,  there  is  good  reason  to  believe  that  the  greatesl 
service  rendered  by  the  Carey  Act  to  investors  in  irrigation  bonds 
is  the  state  validation  of  land  and  water  titles  that  is  implied  when 
the  Engineer  grants  a  permit  for  construction. 

1235.  The  Scale  of  Carey  Act  Projects.  Carey  Act  lands  are 
usually  in  very  large  tracts.  Were  it  not  for  their  merchantabilily 
r/.s  land  bargains,  this  would  be  a  serious  objection,  for  it  would 
mean  heavy  carrying  charges  during  the  construction  period,  and 
until  the  land  with  its  water  rights  was  sold.  As  it  is,  however,  the 
scale  on  which  these  properties  are  planned  is  to  their  advantage, 
since  it  allows  for  most  economical  operation.  And  again,  owing 
to  the  low  cost  of  undeveloped  Carey  lands,  the  expense  of  selling 
water  rights  is  usually  very  small,  as  compared  with  the  expense 
of  selling  the  lands  of  private  systems.  Moreover,  the  scale  of 
the  Carey  projects  permits  broadcast  advertising  in  which  the 
railroads  gladly  assist  for  the  upbuilding  of  the  country.  Thereby 
the  selling  cost  per  acre  is  very  much  reduced. 

1236.  Summary.  In  summary,  irrigation  bonds  are  almost 
always  prior  liens,  and  in  Carey  Act  and  private  projects 
"  first  and  only "  liens,  on  waterworks  and  reclaimed  land,  or 
on  land  about  to  be  reclaimed.  Their  priority  as  liens  is  a 
recognition  of  the  commercial  primacy  of  irrigation  in  the  arid 
West. 

1237.  In  municipal,  or  in  Carey  Act  projects,  the  bonded  indebt- 
edness represents,  or  should  represent,  the  approximate  cost  of 
construction,  with  reasonable  interest  and  profits,  and  in  any  case, 
it  is  secured  by  property  usually  worth  several  times  the  amount 
of  the  issue,  as  soon  as  the  lands,  with  their  inseparable  water 
rights,  are  possessed  and  cultivated  by  settlers.  If  Irrigation  Dis- 
trict Bonds,  they  have  the  same  formal  characteristics  as  other 
Municipal  District  Bonds,  and  they  are  legitimately  called  Mu- 
nicipals. If  corporation  bonds,  issued  in  accordance  with  the  Carey 
Act,  they  have  met  with  Government  sanction  and  with  state  super- 
vision and  approval.  If  Serial  Irrigation  Bonds,  the  equity,  or 
margin  of  safety,  grows  from  year  to  year,  as  in  Serial  Equipment 
Bonds;  but  unlike  Equipment  Bonds,  the  material  security  ordi- 
narily does  not  depreciate,  but  rather  enhances  rapidly,  through 
growth  in  land  values.    But,  to  repeat,  it  does  not  follow  from  the 


PRIVATE  PROJECT  AND  CAREY  ACT  BONDS       399 

foregoing  that,  as  a  whole,  the  security  for  Irrigation  Bonds  is 
comparable  with   that   of   Equipments. 

1238.  Disadvantages.  As  a  channel  of  investment  Irrigation 
Bonds  have  drawbacks  as  obvious  as  their  excellences.  The  legal 
aspect  of  the  disadvantages  has  been  mentioned.  Furthermore,  it 
cannot  be  gainsaid  that,  after  all,  Irrigation  Bonds,  irrespective  of 
kind,  represent  at  the  time  they  are  issued  the  funding  of  loans 
that  are  to  pay  for  future  developments;  and  these  developments, 
in  common  with  all  construction  propositions,  have  elements  of 
risk.  No  amount  of  legislative  direction  and  restriction,  of  itself, 
will  assure  success  to  an  irrigation  proposition.  The  financial 
record  of  irrigation  has  been  fairly  clean ;  but  some  district  private 
projects,  and  at  least  one  Carey  Act  project,  have  fallen  into  diffi- 
culties. There  are  not  wanting  those  who  believe  much  trouble  is 
yet  to  come  because  of  overcapitalization  and  misguided  enterprise. 
As  distinguished  from  most  municipal,  railroad,  and  corporation 
bonds,  the  immediate  security  for  irrigation  issues  is  land  value, 
rather  than  credit  or  earning  power,  and  the  value  must  be  in  the 
land.  But  the  value  of  the  land  is  dependent  on  an  unfailing  supply 
of  water,  on  fertility  of  soil,  a  market  for  its  products,  and  trans- 
portation to  that  market,  and  lastly,  on  the  character  and  per- 
manency of  the  settlement.  To  ascertain  these  facts  at  first  hand 
and  beyond  peradventure  is  difficult.  Reliance  must  be  placed  on 
the  bond  house  that  sells  the  security.  Of  all  classes  of  bonds  these 
most  particularly  should  be  bought  only  of  bankers  who  are  trust- 
worthy, and  conversant  with  the  construction  and  financial  prob- 
lems of  the  securities  they  offer. 

1239.  The  indifference  of  Eastern  houses  x  to  irrigation  projects 
is  due,  in  part,  to  their  unfamiliarity  with  the  field,  and  it  may  be, 
to  an  unwillingness  to  go  to  the  heavy  expense  necessary  for  a 
proper  investigation  of  any  project  that  may  be  offered  to  them, 
since  the  successful  disposition  of  the  issue  among  their  clientele 
might  be  a  matter  of  question.  And  since  in  Carey  Act  projects  the 
corporate  life  of  the  irrigation  company  terminates  when  the  works 
are  handed  over  to  the  settlers,  there  is  not  the  incentive  of  a  stock 
bonus  with  prospect  of  increase  in  value,  which  the  ordinary  public 
utility  enterprise  offers  to  a  banking  house  that  will  promote  it. 
But  apart  from  such  considerations  there  remains  that  deep- 
rooted  distrust  of  what  the  future  may  have  in  store,  especially 

1  Only  one  Eastern  house  of  standing  regularly  handles  irrigation  issues. 


400  RECLAMATION  ISSUES 

for  the  municipal  and  private  undertakings,  many  of  which  have 
been  bonded  for  much  more  than  their  cost. 

1240.  Market  and  Net  Return.  The  principal  market  for  Irriga- 
tion Bonds,  therefore,  is  in  the  Middle  West;  and  this  fact  coupled 
with  the  unwillingness  of  many  houses,  East  and  West,  to  handle 
them  at  all,  deprives  most  of  the  issues  of  a  ready  market.  But  it 
is  not  surprising  that  they  tempt  investors  who  know  something  of 
the  success  of  irrigation  as  an  agricultural  enterprise,  for  the 
bonds  are  usually  sold  to  net  from  G  to  6£  per  cent.  The  State 
of  Colorado  thinks  well  enough  of  her  own  irrigation  district  bonds 
to  permit  them  to  be  bought  for  the  state  school  fund.  They  are 
also  purchased  there  by  national  banks. 

1241.  Future.  It  is  remarkable  what  has  been  accomplished  in 
the  last  few  years  in  reclaiming  the  arid  lands  of  the  United  States. 
The  Reclamation  Service  reports  that  plans  thus  far  made  and 
approved  call  for  the  irrigation  of  3,171,000  acres  at  an  outlay  of 
$97,000,000,  as  the  result  of  which  the  lands  benefited  will  have 
a  minimum  value  of  $150,000,000.  When  one  remembers  the  im- 
mense engineering  feats  of  the  San  Joaquin  Valley,  New  Mexico's 
hundred  thousand  acres  of  desert  in  Pecos  Valley  turned  into  till- 
able fields,  and  the  South  Platte  Valley  of  Nebraska,  WTyoming,  and 
Colorado,  with  its  two  million  acres  artificially  watered,  it  seems 
as  if,  quite  apart  from  Government  operations,  Eastern  capital  must 
have  been  drawn  upon  sufficiently  to  make  this  kind  of  enterprise 
familiar. 

It  may  be  only  a  matter  of  time  and  development  before  the 
East  changes  its  attitude  toward  Irrigation  Bonds.  The  total  of 
our  engineering  efforts  hitherto  is  as  nothing  compared  with  what 
has  been  accomplished  by  the  Nile  dam  at  Assuan  in  watering 
6,000,000  acres,  or  by  the  Ganges  Canal,  which  fertilizes  and  makes 
habitable  even  twice  this  amount.  Less  than  10  per  cent,  of  the 
total  redeemable  area  in  the  United  States  has  been  reclaimed,  and 
as  the  West  leans  less  heavily  upon  Government  subvention  and 
more  upon  local  resources  and  private  enterprise  we  may  see  Irri- 
gation Bonds  of  the  municipal  and  Carey  types  dealt  in  more  freely 
throughout  the  country. 


CHAPTER  XXXIII 
RECLAMATION  ISSUES:   DRAINAGE  AND   LEVEE   BONDS 

1242.  Levee  and  Drainage  bonds  are  the  prevention  and  cure, 
respectively,  of  the  opposite  evil :  too  much  venter.  Both  kinds  of 
construction  are  now,  and  will  be,  financed  in  the  same  spirit  and 
for  the  same  purpose  as  irrigation  works.  The  spirit,  as  we  have 
said,  is  that  fostered  by  a  community  of  interest,  resulting  in  local 
cooperation  under  government  regulation  and  guidance;  and  the 
purpose,  the  furtherance  of  profitable  agriculture  in  lands  that 
hitherto  have  been  wholly  or  partially  unproductive. 

1243.  Scope  and  Character.  Drainage,  on  a  large  scale,  has  been 
confined  thus  far  to  states  bordering  on  the  Ohio  and  Mississippi 
rivers,  but  within  this  field  its  operations  have  been  very  extensive. 
Particularly  in  Ohio,  Indiana,  Illinois,  and  Iowa,  under  intelligent 
state  drainage  laws  the  soil  that  formerly  was  waste  has  been 
brought  to  a  condition  of  high  culture;  and  on  the  Mississippi 
from  Cairo  to  New  Orleans  there  is  a  fairly  continuous  stretch  of 
fertile  land  reclaimed  from  the  river  by  levees. 

1244.  Although  much  has  been  done,  the  work  of  drainage  and 
levee  reclamation  is  but  well  under  way,  and  loans  are  constantly 
being  made  in  furtherance  of  both.  It  has  been  found  desirable 
to  finance  these  improvements  by  municipal  corporations  of  one 
sort  or  another.  Occasionally  a  city  will  assume  drainage  or  levee 
charges  as  direct  obligations,  e.g.  Dayton,  Ohio;  but  by  far  the 
larger  number  of  drainage  issues  are  in  the  form  of  county  and 
district  loans.  In  either  circumstance  the  bonds  are  to  be  looked 
upon  as  any  other  municipals  issued  for  improvement  purposes  and 
to  be  judged  in  accordance  with  the  credit  of  the  community,  its 
character,  population,  valuation,  tax-burden,  debt  limit,  etc.  In 
the  nature  of  the  case  levee  construction  is  a  benefit  to,  and  there- 
fore a  tax  obligation  of,  cities  and  strips  of  land  rather  than  of 
counties  as  a  whole,  therefore  levee  bonds  are  usually  Municipal  or 
Levee  District  issues. 

401 


402  RECLAMATION  ISSUES 

1245.  Security.  Levee  District  and  Drainage  District  bonds  are 
not  dissimilar  to  irrigation  District  bonds,  or  to  District  bonds  in 
general.  In  addition  to  the  usual  considerations  governing  invest- 
ment in  district  issues,  one  should  post  himself  as  to  the  laws  of 
the  several  states  affecting  drainage  districts;  and  he  should  re- 
member that  drainage  districts  have  the  same  rural  credit  char- 
acteristics as  irrigation  districts.  At  present  Illinois,  Louisiana, 
and  Missouri  put  forth,  for  drainage  purposes,  District  bonds  ex- 
clusively; Iowa  issues  both  District  and  County  bonds,  but  the 
former  are  greater  in  number  and  amount.  Ohio  and  Minnesota 
issue  all  their  "  Ditch  ':  (Drainage)  bonds,  as  city  or  county  obli- 
gations,  in  Large  numbers  and  small  amounts.  Each  of  these  states 
made  about  21  such  loans  in  1907,  aggregating  about  $280,000,  and 
$500,000  respectively.  Iowa,  with  both  County  and  District  issues, 
spent  nearly  $1,000,000.  Mississippi,  North  Dakota,  Indiana, 
Louisiana,  Nebraska,  California,  and  even  Massachusetts  brought 
out  one  or  two  issues  under  this  title. 

1246.  Levee  construction  has  not  required  much  money  recently. 
Perhaps  a  million  dollars  a  year  will  cover  the  demands.  Arkansas, 
Louisiana,  California,  Ohio,  and  Illinois  have  been  prominent  in 
these  betterments.  The  requirements  for  drainage  are  three  or  four 
times  as  great. 

1247.  Municipal  Drainage  Bonds  are  held  in  comparatively 
high  esteem  in  the  West  when  from  good  states.  In  Ohio  more  are 
issued  as  4s  or  4£s  than  as  5s  and  they  are  often  sold  at  a  premium 
to  the  local  national  banks.  A  plurality  of  recent  Minnesota  issues 
are  4s,  although  some  are  5s  and  (is.  They  are  bought  freely  by 
the  State  Board  of  Investment  just  as  Colorado  Irrigation  District 
bonds  are  bought  for  the  state  school  fund,  and,  in  fact,  the 
Louisiana  "  Parish  "  Levee  District  bonds  do  go  to  the  state  school 
fund.  Iowa  Drainage  Districts  are  bought  by  banking  and  in- 
surance companies  operating  in  the  state.  With  these  facts  in 
mind  it  is  sale  to  say  that  when  such  municipal  bonds  are  pur- 
chased from  Western  houses  of  repute  or  Eastern  houses  with 
Western  offices  or  connections  that  are  conversant  with  local  con- 
ditions, they  otter  a  degree  of  security  at  least  comparable  with 
that  of  corporation  bonds  of  like  income. 

1248.  Net  Return.  An  Eastern  capitalist  would  have  nothing 
to  gain  by  competing  with  Ohio  banks  to  get  the  issues  of  that 
state  on  less  than  a  4  per  cent,  basis.    But  drainage  5s  and  6s  bought 


DRAINAGE  AND  LEVEE  DISTRICT  BONDS  403 

intelligently  at  about  par  are  attractive  investments.  So  far  as 
can  be  computed,  the  average  income  basis  at  which  the  bonds  of 
1907  were  originally  sold  by  municipalities  to  banks,  bond  houses, 
and  investors  was  4.867  or  4|  per  cent. 

1249.  Duration.  There  is  as  wide  a  range  in  maturities  as  in 
security  and  income  yield.  The  duration  is  from  one  to  fifty  years, 
the  average  is  now  slightly  over  eight  years.    Most  issues  are  serial. 

1250.  Market.  The  market  for  the  city  and  county  issues  de- 
pends, of  course,  on  the  demand  for  the  other  loans  of  the  same 
municipalities.  Drainage  and  Levee  District  securities  suffer  by 
comparison. 

1251.  Future.  The  whole  Atlantic  seaboard,  from  Maine  to 
Florida,  is  fringed  with  strips  of  salt  marsh  land  that  need  only 
the  application  of  plant  chemistry  and  hydraulics  on  the  one  hand 
and  public-spirited  financial  endeavor  on  the  other  to  redeem  them 
for  the  intensive  agriculture  that  increasing  congestion  of  popula- 
tion demands.  In  certain  sections,  private  enterprise  has  already 
accomplished  a  great  deal.  Malarial  tide-marshes,  formerly  worse 
than  worthless,  have  been  redeemed  from  rank  grass  and  mosquitoes, 
and  made  to  yield  most  desirable  products.  Good  cranberry  bogs 
made  from  such  land  on  the  New  England  coast  are  worth 
$1,000  the  acre.  Here,  and  on  the  South  shores,  small  garden 
truck,  raised  from  the  drained  marshes,  has  proved  well  worth 
while. 

1252.  But  these  industries  are  sporadic.  What  is  wanted  for  a 
general  development  of  tide  lands  is  the  knowledge  and  confidence 
on  the  part  of  whole  communities  that  their  united  endeavors  for 
reclamation  will  be  fruitful  and  lasting.  Toward  this  end  the 
United  States  Department  of  Agriculture,  through  its  experiment 
stations  and  drainage  engineers  is  perfecting  plans  for  a  system  of 
sea-coast  drainage  and  agriculture,  and  has  submitted  to  the  Fed- 
eral Government  recommendations  that  will  help.  The  main  con- 
tention of  the  Department  is  that  each  state,  having  within  its  bor- 
ders considerable  salt  marsh,  should  establish  simple,  but  equitable 
drainage  laws  that  would  protect  those  who  bear  the  burden  of 
development.  Such  laws  should  establish  the  riparian  rights  of 
the  landowners  and  "  should  also  make  provision  for  doing  the 
reclamation  work  as  a  whole  and  provide  for  the  issuance  of  bonds 
to  be  a  lien  upon  the  lands  benefited,  to  raise  money  for  paying 
for  the  work  as  it  is  done.  These  bonds  should  run  for  a  long  term 
of  years  at  a  low  rate  of  interest  and  be  paid  in  annual  instalments 


404  RECLAMATION  ISSUES 

by  a  tax  on  the  land  reclaimed  in  the  ratio  that  such  lands  are 
benefited  by  the  improvement."  1 

So  it  seems  that  there  is  an  extended  future  for  drainage  and 
levee  issues,  and  in  localities  that  will  bring  them  more  closely 
home  to  Eastern  capital.  Therefore  they  deserve  a  greater  amount 
of  attention  than  they  are  now  receiving  in  the  East. 

1  See  the  Annual  Report  of  the  Office  of  Experiment  Stations  for  the  fiscal  year 
1906. 


PART  IV 

THE  MATHEMATICS  AND  MOVEMENT  OF 

BOND  PRICES 

CHAPTER  XXXIV 

THE  MATHEMATICS  OF  BOND  VALUES 

1253.  We  have  now  discussed  many  of  the  important  aspects  of 
bonds  as  a  channel  for  investment ;  but  before  we  consider  the  gen- 
eral course  and  the  minor  movements  of  bond  prices,  it  will  be  well 
to  run  over  those  practical  problems  of  a  mathematical  sort  that 
every  investor  has  to  meet  when  he  figures  the  income,  cost,  present 
value,  or  selling  price  of  a  bond.  Then,  too,  some  defensible  stand 
must  be  taken  as  to  how  an  investor  should  keep  his  books  to  know 
at  any  time  what  is  his  capital  invested  in  bonds,  and  to  compare 
this  "  capital  estate "  with  the  estimated  market  value  of  his  se- 
curities. Or,  if  he  is  acting  in  a  fiduciary  capacity,  that  he  may 
distinguish  what  is  legally  capital  in  this  case  from  what  is  income, 
in  order  to  render  the  income  to  the  life-tenants  (the  annuitants), 
and  the  principal  to  the  remainderman.  Bond  accountancy,  there- 
fore, naturally  divides  itself  into  The  Mathematics  of  Bond  Values, 
with  its  application  to  the  bond  tables,  etc.,  and  The  Basis  of 
Bond  Accounts. 

1254.  Net  Returns.  It  may  be  said,  at  the  outset,  that  most 
of  the  difficulties  met  in  figuring  investment  values  arise  from  the 
fact  that  the  net  return  is  usually  different  from  the  periodical  cash 
return  which  the  investment  produces.  Whether  the  investment 
have  a  maturity  or  not : — whether  it  be  stock,  mortgage,  or  bond, — 
if  bought  at  par,  so  that  the  net  return  and  the  cash  return  are  the 
same,  there  can  be  no  questions  of  moment  raised  concerning  value.1 

1255.  Net  Dividend  Yield:  Perpetual  Securities.  Value  is  most 
significantly  expressed  in  terms  of  income.  Indeed  we  may  say 
yield  is  the  only  common  denominator  of  security  values.    The  sim- 

1  A  compounding  of  interest  or  dividends,  due  to  conversions  more  frequent 
than  once  a  year,  will  cause  an  almost  inappreciable  difference  in  the  net  rate, 
and  therefore  in  the  price.  But  the  bond  tables  neglect  this,  and  call  the  net 
yield  of  a  4  per  cent,  bond  at  par,  4  per  cent.,  irrespective  of  the  interest  interval. 

406, 


406  THE  MATHEMATICS  OF  BOND  VALUES 

plest  study  of  values  is  to  be  found  in  figuring  the  net  return  of 
securities  thai  have  no  fixed  date  of  repayment,  and  are  not  truly 
loans.  Perpetual  or  interminable  loans,  such  as  the  Republic  of 
Cuba  (Internal  Debt)  5s,  and  the  British  Consols,  and  among 
American  private  corporation  bonds,  the  Securities  Company  4  per 
cent.  Consols,  arc  of  this  class,  tl  refore  the  matter  is  pertinenl  to  a 
bond  (realise.  But  slocks  predominate  among  non-maturing  se- 
curities. The  returns  that  come  from  stocks,  therefore,  may  well 
designale  what  we  usually  seek  in  figuring  such  security  values: 
namely.  Net  Dividend   Yield.1 

1256.  The  rate  of  net  dividend  yield  may  be  defined  as  the 
ratio  of  the  annual  cash  dividend  to  the  price  paid.  It  is  very  sim- 
ple. If  a  stock  costs  $110,  and  the  dividends  for  the  year  amount 
to  $4,  the  annual  net  dividend  return  will  be  Tfg-  =.03448  .  .  .  .  = 
3.448  ....  per  cent.=3.45  per  cent.,  approximately. 

1257.  It  will  be  seen  that  it  is  not  necessary  to  know  the  par 
value  of  a  stock  to  find  the  net  yield,  if  we  know  the  cash  dividend. 
This  is  convenient  to  remember  when  figuring  the  yield  of  mining 
and  other  low-priced  stocks.  We  may  have  forgotten  that  the  par 
value  of  Butte  Coalition  is  $15,  but  at  a  cost  of  $20,  we  can  easily 
figure  that  the  net  yield  of  this  stock,  when  it  is  paying  25  cents 
in  dividends  quarterly  each  year,  is  5  per  cent. 

1258.  The  ordinary  stock  tables,  however,  are  not  based  on  cash 
dividends  or  an  eclectic  par  value.  Like  New  York  Stock  Ex- 
change quotations,  they  are  based  on  a  par  value  of  $100,  and 
treat  the  dividend  as  percentage.  A  stock  like  Reading  Common, 
with  a  par  value  of  $50  and  with  $3  dividends  a  year,  is  treated 
like  a  6  per  cent,  stock  of  $100  denomination.  The  result,  of  course, 
is  the  same,  for  the  ratio  remains  the  same ;  but  having  doubled  par 
to  get  the  interest  rate  in  percentage,  it  is  necessary  to  double  the 
price  to  maintain  its  proportionate  relation  to  par  in  finding  the 
net  yield. 

1259.  To  find,  in  the  tables,  the  net  yield  of  stocks  that  have  a  par 
value  of  less  than  $100,  multiply  the  price  in  the  price  column  by 
the  number  of  times  the  par  value  is  contained  in  the  $100,  and  seek 
the  corresponding  decimal  in  the  interest  rate  column.    But,  if  the 

1  There  is  one  rent  distinction  between  dividends  and  the  revenues  from  per- 
petual loans:  the  dividend  ordinarily  is  optional,  therefore  instantaneous;  the 
loan-revenue  is  obligatory,  therefore  accruing.  Cumulative  preferred  stocks,  with 
what  might  be  called  semi-obligatory  dividends,  bridge  the  distinction.  Hence 
the  New  York  Stock  Exchange  ruling  that  income  bonds  be  quoted  "  flat." 


THE  MATHEMATICS  OF  BOND  VALUES  407 

par  value  is  more  than  $100,  divide  the  price  by  the  number  of  times 
the  $100  is  contained  in  it.  But  simpler  by  far  than  the  use  of 
any  tables  is  the  division  of  the  cash  dividend  by  the  price  in 
accordance  with  the  definition  of  Net  Dividend  Yield. 

1260.  It  is  the  universal  practice  to  figure  net  dividend  returns 
as  above.  In  view  of  what  is  to  follow,  however,  attention  is  called 
to  the  fact  that  this  method  is  open  to  variation;  for  it  does  not 
take  into  consideration  the  fact  that  some  stocks  pay  dividends 
annually,  some  semi-annually,  and  some  quarterly.  Obviously,  the 
true  return  of  a  stock  paying  8  per  cent,  annually  may  be  considered 
less  than  that  of  a  stock  paying  2  per  cent,  every  quarter  day,  for 
the  owner  of  the  stock  paying  quarterly  has  the  opportunity  to  in- 
vest his  dividends  and  get  as  additional  compensation,  whatever 
interest,  dividends,  or  discount  may  be  had  on  $2  for  9  months,  $2 
for  6  months,  and  $2  for  3  months.  Since  the  reinvestment  of  divi- 
dends is  not  ordinarily  pertinent  to  an  accounting  of  the  transac- 
tion, the  stock  tables  do  not,  of  course,  take  dividend  intervals  into 
account.  If  discrimination  were  made,  as  in  bond  tables,  the  cur- 
rent stock  tables  would  be  those  to  be  used  for  stocks  paying  divi- 
dends annually.  Dividends  are  usually  payable  quarterly.  That 
different  interest  intervals  do  require  different  sets  of  bond  value 
tables  is  for  reasons  other  than  the  payment  of  semi-annual  coupons. 

1261.  Net  Interest  Yield:  Terminable  Securities.  The  rate  of  net 
interest  yield  for  bonds  is  not  so  simple.  It  is  the  ratio  of  the  sum 
that  the  owner  of  the  security  is  entitled  to  entertain  as  income,  to 
the  cost  of  the  security  (accrued  interest  excepted),  considering  the 
length  of  time  before  the  principal  is  to  be  repaid.  The  trouble 
with  this  definition  is  that  it  does  not  define;  for  we  do  not  know 
what  sum  is  the  owner's  true  income. 

1262.  If  the  bond  is  bought  at  a  premium  or  discount,  the  money 
value,  on  any  basis  of  computation,  must  gradually  approach  par, 
since  (with  the  exceptions  already  noted),  par  is  the  value  of  the 
invested  capital  at  maturity.  In  the  nature  of  the  case  the  rate 
the  bond  yields  cannot  change,  and  therefore,  as  the  amount  (or 
present  worth)  of  the  capital  invested  in  the  premium  bond  de- 
creases toward  par,  and  the  amount  of  the  capital  invested  in  the 
discount  bond  increases  toward  par,  the  amount  of  true  income 
decreases  or  increases,  respectively,  in  proportion.  The  net  interest 
rate  must  be  a  constant  ratio. 

1263.  It  is  because  the  amount  of  capital  invested  in  the  bond  (as 
distinct  from  the  sinking  fund)  decreases  or  increases,  as  the  case 


408  THE  MATHEMATICS  OF  BOND  VALUES 

may  be,  that  many  have  the  entirely  erroneous  idea  that  there  is  a 
depreciation  of  an  investment  bought  above  par,  and  an  appreciation 
of  one  bought  below  par.  Let  us  consider  a  $1000  bond  bought  at 
00.01,  having  10  jears  to  run  and  bearing  4  per  cent,  interest.  The 
current  bond  tables,  hereafter  fully  explained,  show  us  that  the  net 
rate  of  yield  on  a  4  per  cent,  bond  costing  $900.10  and  running 
for  10  years,  is  approximately  5.30  per  cent.  After  six  months  the 
value  of  this  bond  at  the  same  net  yield  is,  according  to  the  tables, 
about  $903.90.  Since  no  capital  has  been  added,  why  has  there 
not  been  a  real  appreciation  in  the  value  of  the  instrument?  Be- 
cause this  $3.80  of  gain  in  the  invested  sum  has  been  taken  out 
of  the  earnings,  or  interest. 

1264.  At  the  six  months'  period  the  owner  was  entitled  to  draw 
one-half  of  the  annual  5.30  per  cent,  on  his  invested  principal,  but 
the  limitations  in  flexibility  of  his  instrument  permit  him  to  draw 
(by  cashing  the  coupon)  only  one-half  of  the  4  per  cent,  of  the  par 
value.  The  apparent  gain  in  the  invested  principal  came  from  with- 
holding income  to  which  he  was  entitled  on  a  5.30  per  cent,  basis. 

Bond  value  10  yrs.   prior  to  maturity $900.10 

Bond  value  9^  yrs.  prior  to  maturity 903.90 


The  so-called   "appreciation" $    3.80 

Semi-annual  Net  Yield  ($  of  5.30$  of  900.10)—  $23.85 
Semi-annual   Cash   Yield    (£  of  4#  of  1000)=  20.00 


Amount   Withheld    $  3.85 

(The  discrepancy  of  five  cents  between  the  "appreciation"  and  the  "amount 
withheld  "  is  due  to  the  fact  that  the  shorter  bond  tables  in  common  commercial 
use  carry  values  to  the  second  decimal  only.) 

1265.  It  follows  that  the  sum  of  the  amounts  withheld  for  the  20 
semi-annual  periods  will  equal  the  discount.  By  similar  reasoning 
it  may  be  shown  that  the  difference,  in  a  premium  bond,  between  the 
cash  interest  paid  and  the  lesser  interest  earned  is  equal  to  the  "  de- 
preciation," whether  the  period  be  full  10  years  or  any  other 
duration. 

1266.  A  clear  and  incontrovertible  inference  from  what  has  been 
said  is  that  the  one  mathematical  factor  making  for  bond  values 
is  the  Net  Interest  Rate.    For  this  reason  the  bond  value  tables  are 


THE  MATHEMATICS  OF  BOND  VALUES 


409 


based,  not  on  prices,  but  on  the  somewhat  arbitrary,  but  generally 
informing,  rates  of  net  income. 

1267.  It  is  possible,  however,  to  reverse  this  proposition:  to  con- 
sider the  bond  features  as  factors  determining  the  net  yield.  So 
viewed,  the  net  rate  of  yield  is  affected  by  the  price  paid,  the  sum 
to  be  received  at  maturity,  the  cash  sum  to  be  received  periodically 
as  interest,  the  length  of  time  before  the  principal  sum  will  be 
repaid,  and  the  frequency  of  the  periodic  interest  payments. 

1268.  A  summary  of  the  whole  matter  of  net  yield  reduces  topi- 
cal considerations  to  the  following : — 


Recapitulation : 


The  Factors  of  Net  Return 


Net  Dividend  Yield 


I  Price 

(of  stocks  and  other     J  „    ,   _.  . , 

i  -x-     \       J  Cash  Dividend 

perpetual  securities)      [ 


Net  Interest  Yield 
(of  bonds  and  other 
redeemable  securities 


f  Price 
Redemption  Value 
Nominal  Interest 

Rate 
Duration 
Interest  Interval 


(  Par  Value 
J  Nominal  Dividend 
(     Rate 

{  Premium  or 
1      Discount 


Number  of 

Interest  Periods 


1269.  Ordinarily  the  phrase  "  par  value  "  may  be  substituted  for 
the  more  awkward  "  redemption  value,"  for  most  bonds  are  re- 
deemed at  par.  Then  the  difference  between  the  Price  and  Par 
will  be  the  Premium  or  Discount.  But  when  an  issue  must  6e 
redeemed  at  a  premium,1  or  when  an  issue  has  been  redeemed  at 
a  premium,  and  one  desires  to  know  what  it  has  netted,  the  bond 
tables  do  not  cope  with  the  situation;  resort  must  be  had  to 
formulas. 

1270.  Premium.  How  the  factors  I  Price  and  II  Par,  as  pre- 
mium or  discount,  work  with  III  Nominal  Interest  Rate  to  affect 
the  Net  Interest  Yield,  may  be  seen  in  the  following  illustration : — 
A  $1000  bond,  bearing  interest  at  5  per  cent,  payable  semi-annually 
is  bought  for  $1080  ("at  108")  and  accrued  interest.  The  owner 
is  not  entitled  to  consider  that  his  investment  nets  him  $50  a  year, 
or  5  per  cent,  since  such  part  of  the  $25  cash  interest  paid  each 

1  The  Improved  Property  Holding  Company  (New  York)  6s  must  be  paid  at 
110.     This  is  probably  a  unique  provision  among  American  Corporation  loans. 


410  THE  MATHEMATICS  OF  BOND  VALUES 

semi-annual  interest  date  must  be  laid  aside  for  a  sinking  fund  as 
will  accumulate  an  amount  at  maturity  equal  to  the  $80  premium. 
Otherwise  the  capital  of  $1080  would  be  impaired  at  maturity  to  the 
extent  of  $80.  For  the  accounting  of  a  sinking  fund  for  a  premium 
bond,  sec  §  L381. 

1271.  Discount.  If  the  same  bond  is  bought  for  $920  and  accrued 
interest,  the  owner  is  entitled  to  consider  that  his  investment  nets 
him  more  than  the  $50,  or  5  per  cent,  that  he  actually  receives  each 
year;  for  if,  in  addition  to  his  coupons,  at  the  semi-annual  interest 
dates  he  should  withdraw  from  any  source  and  unite  with  his 
coupon  income  sums  which  would  amount  at  maturity  to  the  $80 
which  the  par  value  exceeded  the  buying  price,  then  this  $80  would 
pay  for  and  offset  the  sums  drawn ;  and  the  capital  of  $920  would 
remain  as  at  the  time  of  investment.  For  the  accounting  of  an 
accumulating  fund  for  a  discount,  see  §  1385. 

1272.  Nominal  Interest  Rate.  It  is  the  effect,  upon  interest  rate, 
of  premium  or  discount,  which  is  wanting  in  stock  computations. 
The  par  value  of  stock,  therefore,  is  no  such  vital  matter  as  the  par 
value  of  bonds. 

1273.  Duration.  In  the  above  illustrations  we  have  not  indicated 
how  great  should  be  the  semi-annual  sums  to  be  laid  aside  as  a 
sinking  fund,  in  the  premium  bond,  or  to  be  borrowed  from  some- 
where against  an  accumulating  fund,  in  the  discount  bond.  Since 
the  total  amount  to  be  made  up  is  to  be  in  hand  at  a  definite 
maturity  date,  the  sum  laid  aside,  or  borrowed,  will  be  affected  by 
IV  the  Duration  of  the  bond.  The  longer  the  bond  has  to  run,  the 
smaller  the  compounded  sum  which  must  be  set  aside  each  time. 

1274.  Interest  Interval.  But  the  sum  laid  aside  each  interest 
date  may  be  looked  upon  as  the  "  future  amount "  of  the  original 
instalment  which  has  compounded  at  the  net  rate.  It  is  customary 
to  consider  this  interest  as  compounded  upon  the  regular  bond 
interest  dates.  Again,  the  more  frequently  it  is  compounded  the 
smaller  the  sum  withdrawn  for  premium  or  discount.  We  have, 
therefore,  a  fifth  factor  affecting  Net  Interest  Yield,  called  Interest 
Interval. 

1275.  Dividend  payments,  we  have  said,  are  usually  quarterly, 
but  it  is  not  necessary  to  consider  the  interval  in  finding  net 
dividend  returns.  Interest  payments  are  generally  semi-annual, 
and  the  ordinary  bond  tables  are  based  on  the  six  months'  interval. 
Unless  otherwise  stated,  this  interval  is  to  be  assumed  hereafter  in 
this  book.    If  the  payments  are  quarterly,  as  in  government  bonds, 


THE  MATHEMATICS  OF  BOND  VALUES  411 

or  if  annual,  then  tables  based  on  periods  of  three  months  or  12 
months  must  be  consulted;  or  else  tables  furnishing  multipliers  by 
which  the  results  obtained  from  the  semi-annual  tables  may  be  con- 
verted to  conform  to  the  new  interest  interval.  If,  however,  no 
such  tables  are  accessible,  the  results  may  be  obtained  by  a  simple 
arithmetical  process  which  is  worked  out  in  the  pages  devoted  to  an 
explanation  of  the  uses  of  the  bond  tables. 

1276.  The  Interest  Rate  on  the  Sinking  Fund.  In  this  illustration 
of  the  effect  of  premium  or  discount  on  net  yield,  we  said  that  the 
fund  set  aside  was  compounded  upon  the  regular  bond  interest 
dates.  For  the  sake  of  clearness  let  us  now  confine  the  discussion 
of  this  point  to  the  case  of  a  premium  bond.  Why  may  the  investor 
who  is  laying  aside  a  portion  of  his  bond  interest,  twice  each  year, 
to  create  a  sinking  fund,  consider  that  the  sinking  fund  should  be 
figured  as  if  compounded  semi-annually?  Because,  if  he  puts  the 
fund  into  the  savings  bank  it  will  compound  semi-annually. 

1277.  This  question  is  seldom  raised ;  but  another  of  like  bearing 
is  not  so  rare:  Why  is  the  interest  earned  by  the  sinking  fund 
assumed  to  be  the  same  as  the  net  interest  yield  of  the  bond?  If 
the  5  per  cent,  bond  of  the  illustration,  bought  at  108,  has  50  years 
to  run,  the  net  yield  is  about  4.60  per  cent.  But  the  owner  cannot 
put  out  a  small  sum  at  interest,  on  equal  security,  to  net  4.60  per 
cent.,  in  all  probability.  The  best  he  can  do  is  the  savings  bank, 
at  3|  or  4  per  cent.,  compounded  quarterly.  The  illustration 
would  be  more  striking  in  a  bond  netting  6  per  cent. 

1278.  The  answer  to  both  questions  is  the  same.  We  are  dealing 
with  mathematical  tables,  which  should  be,  as  far  as  possible,  of 
universal  application — ubiquitous  and  perpetual.  The  present  prin- 
ciples of  the  bond  value  tables  presuppose  an  ability  on  the  part  of 
the  owner  to  do  with  small  sums  exactly  what  he  can  with  $1000. 
If  he  can  compound  his  bond  principal  semi-annually  (is  the  in- 
ference), he  can  compound  his  sinking  fund  semi-annually;  it  is 
not  right  to  assume  another  kind  of  investment  in  which  he  can  do 
differently.  Likewise,  if  he  can  net  4.60  per  cent,  upon  his  bond 
principal,  he  can  net  4.60  upon  his  sinking  fund.  In  a  sense,  the 
very  fact  that  the  tables  are  figured  upon  that  basis  makes  the  sink- 
ing fund  earn  4.60  per  cent.  It  is  fairer  to  assume  he  can  earn  that 
rate  than  that  he  can  earn  any  other  rate  arbitrarily  chosen. 

1279.  As  to  the  sinking  fund  interest  rate,  the  advocates  of  a 
more  inductive  method  of  forming  the  tables  say:  Let  the  rate 
accord  with  the  fact :  3^  to  4  per  cent.,  only,  can  be  earned  on  small 


412  THE  MATHEMATICS  OF  BOND  VALUES 

sums  at  interest.    Le1  some  such  average  rate  be  taken  which  will  be 
approximately  correct  over  ;i  long  period  of  years. 

1280.  Granted  that  the  matter  is  of  sufficient  importance  to 
overcome  the  obstacles  to  change,  legal  and  otherwise— is  it  possible 
to  agree  upon  a  rate  which,  in  all  probability,  over  a  period  of  a 
century,  and  from  London  to  Tokio,  and  from  Seattle  to  Bombay, 
will  approximate  the  facts  more  closely  than  the  present?  If  so, 
the  change  would  appeal  to  the  writer.  As  it  is,  he  cannot  refrain 
from  quoting  against  the  proposal  for  a  single  fixed  interest  rate, 
for  the  sinking  fund,  the  words  of  a  friend  who  is  one  of  the  most 
prominent  advocates  of  the  principle :  "  Tables  issued  a  few  years 
ago,  during  the  prevailing  low  rates  of  money  are  of  little  value  to- 
day, when  the  rates  have  so  largely  increased."  If  a  few  years 
will  antiquate  prevailing  interest  rates,  what  may  not  a  century 
do?  From  1892  to  1902  there  was  an  uninterrupted  annual  fall  in 
the  average  rate  of  dividends  paid  by  Massachusetts  savings  banks 
from  4.11  to  3.71,  and  from  1903  the  rate  has  steadily  risen  from 
3.71  to  3.95  per  cent.  (190S.) 

1281.  There  is  some  semblance  of  universality,  and  therefore  more 
reason,  in  establishing  quarterly  intervals  for  compounding  sinking 
funds.  It  is  quite  improbable  that  the  time  will  ever  come  when 
small  investments  cannot  receive  quarterly  interest.  The  doubt  in 
this  case  may  well  be  whether  quarterly  interest  may  be  had  in 
those  parts  of  the  world  which  do  not  provide  savings  institutions 
for  the  public. 

1282.  When  the  matter  is  thus  viewed  in  proper  perspective,  one 
grows  more  content  with  things  as  they  are,  however  crude. 
Further  discussion  of  the  interest  rate  of  the  sinking  fund  will  be 
pertinent  on  deriving  the  bond  formulas. 

1283.  Inaccuracies  in  the  Determination  of  the  Bond  Tables.  Before 
concluding  the  subject  of  Net  Yield,  it  is  desirable  to  call  attention 
to  the  extent  to  which  investment  tables  may  be  relied  on.  As  far 
as  stocks  are  concerned  we  have  found  no  variant  which  under- 
mines the  mathematical  accuracy  of  the  results.  The  only  variant 
discussed  was  that  of  the  dividend  interval,  and  that  offered  no 
difficulties  in  determining  the  net  dividend  yield. 

1284.  In  bonds  there  are  several  variants,  two  of  which, — the 
Interest  Interval,  and  the  Interest  Kate  credited  as  earned  by  the 
fund  raised  to  amortize  the  premium  or  discount — have  already  been 
noted.  This  latter  variant  will  bear  further  thought.  Since  4  per 
cent,  is  the  present  approximate  average  interest  rate  which  small 


THE  MATHEMATICS  OF  BOND  VALUES      413 

invested  sums  will  return,  the  higher  the  net  yield  of  the  bonds 
(above  4  per  cent.)  the  greater  the  discrepancy  between  the  bond 
tables  and  the  facts.  Whether  the  bond  sells  at  a  premium  or  at 
a  discount,  if  the  net  yield  is  greater  than  4  per  cent,  the  interest 
credited  to  the  amortization  fund  is  greater  than  the  facts  warrant. 
Therefore,  the  bond  owner  is  not  putting  sufficiently  large  semi- 
annual sums  into  tbe  fund.  Therefore,  the  owner  of  the  premium 
bond  should  set  aside  out  of  his  cash  interest  payments  a  larger 
sum  semi-annually,  and  the  owner  of  the  discount  bond  may  borrow 
larger  semi-annual  sums,  in  anticipation  of  the  "  discount "  paid 
him  at  maturity, — than  the  bond  tables  authorize. 

1285.  In  other  words,  the  present  bond  tables  work  in  favor  of 
the  principal  and  tbe  owner  of  the  principal,  of  both  premium  and 
discount  bonds,  and  therefore  against  the  recipient  of  the  interest, 
if  another  person, — always  provided  that  the  net  yield  is  over  4 
per  cent.  This  is  not  a  matter  of  importance,  except  when  it 
becomes  necessary  to  separate  principal  and  income  according 
to  testamentary  provisions. 

1286.  Put  in  another  way  still,  the  purchaser  of  a  premium 
bond  which  nets  over  4  per  cent.,  according  to  the  bond  tables,  does 
not  get  as  great  a  return  as  the  tables  indicate;  but  neither  does 
the  purchaser  of  a  discount  bond ;  for  in  the  case  of  bonds  netting 
over  4  per  cent,  the  tables  credit  the  amortization  fund  of  the  one, 
and  the  accumulation  fund  of  the  other,  with  an  ability  to  earn 
more  than  they  really  can  in  the  way  of  interest. 

1287.  On  the  other  hand,  this  disadvantage  is  somewhat  offset 
by  the  fact  that  funds  can  be  compounded  quarterly  in  this  part 
of  the  world,  although  the  tables  assume  that  they  are  to  be  com- 
pounded semi-annually. 

1288.  The  third  source  of  inaccuracy  arises  from  the  assumption 
of  the  tables  that  the  semi-annual  instalments  of  the  amortization 
fund  will  be  instantly  reinvested.  Although  some  banks  allow  in- 
terest on  daily  balances,  the  savings  banks,  which  pay  interest  most 
liberally,  are  accustomed  to  start  new  interest  accounts  only  quar- 
terly. 

1289.  A  fourth  source  is  to  be  found  whenever  a  bond  is  bought 
at  any  other  time  than  on  dates  of  interest  payment.  Conceding  the 
principles  on  which  the  ordinary  tables  are  established,  they  are 
mathematically  correct  to  two  decimal  places  as  to  the  percentage 
of  net  return,  when  no  interest  has  accrued  on  the  price  that  is 
the  basis  on  which  they  are  figured  for  semi-annual  periods.     Ac- 


414  THE  MATHEMATICS  OF  BOND  VALUES 

cruing  interest  is  an  increment  of  the  cost  to  which  the  interest 
yield  can  be  adjusted. 

1290.  The  fifth  source  of  inaccuracy  is  due  to  the  fact  that  the 
values  are  ratios,  and  since  ratios  involve  many  decimal  figures, 
and  are  seldom  divisible  without  a  remainder,  the  tables  are  cor- 
rect only  to  a  given  number  of  decimals,  usually  two.  For  large 
operations  a  valuable  set  of  extended  bond  tables  has  been  compiled, 
which  gives  to  the  nearest  cent  the  value  of  an  investment  of 
$1,000.0(10. 

1291.  As  a  whole  these  five  sources  of  inaccuracy  in  the  deriva- 
tion  of  the  net  yield  are  no  retlection  on  the  tables,  but  rather  a 
testimony  to  the  vicissitudes  attending  the  strictest  investment.  In 
a  measure,  they  counteract  one  another;  and  in  transactions  in- 
volving moderate  amounts  they  are  quite  negligible. 

The  nearer  to  par  and  to  an  interest  period  a  bond  is  bought,  the 
less  the  discrepancy  between  the  facts  and  the  results  obtained  from 
the  tables. 

1292.  Summary  op  Inaccuracies  in  the  Determination  of  Net 

Yield 

Dividend  Interval, 
Net  Dividend  Yield        Decimal    approximation,    if   determined   by 

Dividend  Tables. 

Interest  interval  of  the  amortization  or 
accumulation  fund, 

Interest  rate  of  the  amortization  or  accumu- 
lation fund, 

Implied  instantaneous  reinvestment  of  the 
fund, 

Accrued  interest, 

Decimal    approximation. 

Those  who  have  read  the  preceding  pages  of  this  chapter  and  real- 
ize the  capabilities  and  limitations  of  the  tables,  but  who  are  in- 
terested only  in  the  superficial  business  use  of  them,  may  well  drop 
the  argument  at  this  point,  to  pick  it  up  conveniently  in  §§  1314 
et  seq.,  which  discuss  bank  discount. 

1293.  The  Derivation  of  the  Bond  Formulas.  The  explanation  of 
how  the  tables  are  derived  is  somewhat  complicated  at  best,  there- 
fore of  the  several  possible  formulas,  the  two  have  been  chosen  for 


Net  Interest  Yield 


THE  MATHEMATICS  OF  BOND  VALUES      415 

derivation  which  are  easiest  of  understanding  to  those  who  are 
rusty  in  their  mathematics.    They  are  not,  however,  the  shortest. 

1294.  We  have  defined  the  net  interest  rate  as  the  ratio  of  the 
net  income  to  the  cost.  Instead  of  deriving  our  formulas  from  the 
relationship  expressed  in  this  form  it  will  be  better  to  start  with 
an  entirely  different  but  equally  true  definition  or  equation. 

1295.  The  First  Formula.  A  bond  is  a  promise  to  pay,  I,  a  fixed 
"  principal  sum  "  at  maturity,  and  II,  equal  proportionate  parts  of 
the  principal,  called  interest  (usually  in  the  form  of  coupons)  at 
regular  periods.  The  principal  sum,  or  par,  is  not  worth  par  now, 
since  it  is  a  future  payment;  but  the  present  worth  of  it  may  be 
found,  since  we  know  that  the  entire  investment,  and  therefore 
every  part  of  it,  nets  a  certain  percentage  of  return.  Also  all  the 
future  interest  payments,  and  their  sum,  may  easily  be  computed 
and  the  present  worth  ascertained  at  the  same  net  interest  rate. 
Then  the  present  worth  of  the  bond,  at  the  given  rate, — which  is 
the  price  of  the  bond, — is  simply  the  sum  of  the  present  worths 
of  the  par  value  and  of  the  coupons. 

1296.  And  so,  without  a  book  of  tables,  the  price  of  a  bond  at 
any  net  rate  may  be  computed  by  any  one  who  has  at  hand  tables 
of  compound  interest  and  of  annuities,  for  the  interest  payments 
are  nothing  more  or  less  than  annuities. 

1297.  This  definition  of  the  present  worth  of  the  bond  furnishes 
us  with  the  equation  which  is  the  basis  of  the  formula.  For  con- 
venience let  us  assume  that  the  bond  is  of  $1,  instead  of  f  1000, 
denomination. 

Present  worth  $1  bond=present  worth  of  $1  plus  present  worth 
of  coupons. 
Let  C=cash  or  coupon  payment  in  cents  (or  percentage  of  $1) 
each  semi-annual  interest  period. 
n=nuinber  of  semi-annual  interest  periods. 
N=net  interest  on  $1  for  6  months. 

1298.  To  Find  the  Present  Worth  of  $1  Principal. 

Now  we  seek  the  future  amount  of  a  present  sum,  when  com- 
pounding interest,  by  multiplying  that  sum  by  1  plus  the  interest 
rate  (1+N)  to  get  a  new  amount,  1  (1+N),  and  multiply  this  new 
amount  by  the  ratio  of  increase  (1+N)  to  get  a  second  amount 
1  (1+N)2,  or  (1+N)2,  and  continue  this  process  (1+N)3,  (1+N)4, 
etc.,  for  the  number  of  semi-annual  interest  periods  n,  until  we  get 
ultimate  compound  amount  (1+N)n. 


416  THE  MATHEMATICS  OF  BOND  VALUES 

1299.  For  instance,  if  we  are  compounding  at  the  rate  of  6  per 
cent,  per  annum,  the  semi-annual  amounts  of  fl  would  grow  as 
follows : 

1X1-03=1.03  in  6  mos.,  or  at  1st  period, 
1.03X1.03=  (1.03) 2  at  2d  period. 
(1.03) 2 X  1.03=  ( 1.03) 3  at  3d  period,  and  so  on. 
In  like  manner  at  the  nth  period  the  amount  will  be  (1.03)n,  and 
the  general  formula  is  (1+N)n. 

1300.  So,  in  seeking  the  reverse,  namely,  the  present  worth  of  a 
future  amount,  we  discount,  by  merely  reversing  the  process  of 
accumulation,  and  divide  the  future  amount   ($1)   by  the  ratio  of 

increase  (1+N),  with  the  result  rof  an(^  repeat  .  ,  N.2>  .  .  N  8> 
etc.,  until  the  divisions  equal  the  number  of  interest  periods, — a 
process  expressed  by  ?  which  is  the  formula  for  the  present 

worth  of  $1  principal. 

1301.  Expressed  in  figures,  if  we  are  discounting  at  the  rate  of 
6  per  cent,  per  annum,  the  semi-annual  "  present  worths  "  of  $1 
would  decrease,  according  to  the  duration  of  the  loan,  as  follows : 

Ih-1. 03=j  qo  iu  6  mos.,  or  at  the  1st  period 

-1.03=— ^5X7-^7=     noNgat  the  2d  period 


1.03  1.03    1.03    (1.03)2 

-t-1.03=-j-— v3at  the  3d  period 


1.032  (1.03)J 

At  the  nth  period  the  present  worth  would  be     — - — »    and  the 

r  (1.03)Q 

general  formula  is     ..j,^ 

1302.  To  Find  the  Present  Worth  of  the  Interest  Payments  or 
Coupons, 

Let  us  assume  that  this  $1,  6  per  cent,  bond  runs  2  years  and 
nets  4  per  cent. 

Then  C=.03 

N=.02 
n=4 

As  the  future  values  of  the  coupons  are  each  equal  to  C,  the 
present  worths  are 

c        c         c  c 

1+N'    (1+N)2'   (1+N)3 '(1+N)0 


THE  MATHEMATICS  OF  BOND  VALUES      417 

These  form  a  series  known  as  a  geometrical  progression,  and 
each  term  can  be  obtained  from  the  preceding  by  multiplying  it 


bv 


l 


l  +  N. 
Let  p  denote  the  present  worth  of  all  the  coupons. 

C         C  C  ,    C 


+ 


l+NT(i+N)2  T ^(1+N)*-1    (1+N)n 


Multiplying  by  j—^ 


_P C        _C_  C_     _C_ 

l+N-^+N)8    (l+N)8    +(l+N)«T(l+N)°+» 

By  subtraction 

F    l+N    l+N    (l+N)^1 

Performing  the  subtraction  in  the  first  member,  and  taking  out 

the  factor  1  .  „  in  the  second  member, 

p+pN-p__    C    (1 1_ 

l+N        1+NV       (1+N)n 

Multiplying  by  1-pN, 

1 


pN=C  (1- 


(1+N)» 
Hence 


P    NV      (l+N)"  J 


1303.   Adding  now  the  present  worths  of  the  principal  and  the 
coupons,  the  present  worth  (P)  of  the  bond  is  expressed  thus: 

P=^—  +C/i__l_  ) 

(1+N)n     NV      (l  +  N)"/ 

_     1  C  r(l+N)n-l-| 

~(1+N)n     NL    (1+N)»    J 

N+C  (1+N)n  -C 


N  (l+N)11 


1304.  When  n  is  large,  (l+N)  must  be  solved  by  logarithms.1 
If  N  is  the  unknown  quantity,  it  must  be  doubled  to  get  the  yield 
per  annum.     N  may  be  found  by  the  method  of  approximations. 

1  The  handiest  four-place  logarithmic  tables  that  are  sufficiently  accurate  are 
those  by  Prof.  E.  N.  Huntington  of  Harvard.  They  are  so  arranged  that  they 
can  be  used  very  rapidly. 


418 


THE  MATHEMATICS  OF  BOND  VALUES 


For  example,  a  20-year  4  per  cent,  bond  is  bought  at  95.    Find  the 
rate  of  income  on  the  investment. 
P=Principal=.95 
c=.02 
n=40 
.95=     N-f.02  (1+N)40— .02 

N  (1+N)40 

.95N   (1+N)40=.02   (1+N)40+N— .02 

Since  the  bond  is  sold  at  a  discount  N  is  evidently  greater  than 
.02.     Try  N=.021 


log  .95=9.9777—10 
log  .021=8.3222—10 


log  .02=8.3010- 
log  (1.021)  40=0.3600 


-10 


,vfe      \*-v*-j       v/.wwv 

8.6610—10 

.04581 
.001 

8.6599—10 
.0457 

.04681 

Try  N=.022 

log  .95=9.9777—10 
log  .022=8.3424—10 
log  ( 1.022)  4O=0.3800 

log  .02=8.3010—10 
log  ( 1.022)  40=0.3800 

8.6810—10 

8.7001—10 

.04798 
.002 

.04998 
When  N=.021  the  first  member  is  the  larger;  when  N=.022,  the 
second  member  is  the  larger.    Hence  the  value  of  N  is  between  .021 
and  .022.    As  the  values  of  the  two  members  are  nearer  when  N=.022, 
work  downward  from  that  value. 


Try  N=.0219 

log  .95=9.9777—10 
log  .0219=8.3404—10 
log  (1.0219)  40=0.3780 


log  .02=8.3010- 
log  ( 1.0219)  40=0.3780 


-10 


8.6790—10 


8.6961—10 


.04775 
.0019 


.04967 


.04965 
These  figures  are  as  near  as  could  be  expected.     Therefore  N= 
.0219,  and  2N,  or  the  net  yield  per  annum  is  4.38  per  cent. 


THE  MATHEMATICS  OF  BOND  VALUES  419 

1305.  One  virtue  of  the  first  formula,  especially  in  its  earlier 
stages,  is  the  clearness  with  which  it  shows  the  inaccuracy  of 
valuing  N  in  the  present  worth  of  the  principal  as  equal  to  N  in 
the  present  worth  of  the  coupons.  N  should  be,  and  is  supposed 
to  be,  the  prevailing  rate  of  interest  for  securities  of  the  kind.  But 
the  prevailing  rate  for  f  1000  bonds  is  quite  another  thing  from  the 
prevailing  rate  on  $30  bank  deposits. 

This  reverts  to  the  matter  already  taken  up  at  large: — the  most 
difficult  and  most  controverted  of  all  the  problems  of  bond  mathe- 
matics,— with  what  interest  should  the  coupon  payments  be 
credited?  It  is  not  so  advantageous, — is  it, — to  have  an  invest- 
ment (a  real  estate  mortgage  for  instance)  paid  off  in  small  in- 
stalments as  in  bulk?  Why  not?  Because  the  instalments  cannot 
be  so  advantageously  reinvested;  in  other  words,  cannot  be  rein- 
vested at  such  a  high  rate  of  interest  for  the  same  degree  of  se- 
curity, etc.  If  the  principal  sum  (1_i_N)n  is  invested  to  better 
advantage,  how  can  the  coupon  investment  be  equitably  credited  with 
only  the  advantage  which  can  accrue  to  it?    By  crediting  the  N  in 

the    coupon   investment  ^  (1-(1+1N)n)  with  a  value    that  will  bear 

the  same  relation  to  the  N  in  the  principal  sum  that  the  earning 
power  of  the  coupon  investment  bears  to  the  earning  power  of  the 
principal  sum,  as  in  §  1307. 

1306.  In  a  $1,  two-year  bond  selling  to  net  6  per  cent,  the  in- 
vesting public,  not  realizing  the  inaccuracy  of  the  present  method 
of  computing  the  tables,  and  believing  that  this  particular  grade  of 
security  is  worth  6  per  cent,  as  a  non-serial  investment,  pay  the 
equivalent  price.  If,  however,  they  realized  how  the  bond  tables 
were  computed,  and  if  there  were  a  practical  way  of  meeting  their 
desires,  they  would  borrow  or  lend  at  what  is  truly  the  present 
worth  of  a  round  sum  of  $1000  (determined  by  what  that  sum  could 
now  be  reinvested  for),  plus  what  is  truly  the  present  worth  of  an 
annuity  of  $30  (determined  by  what  each  payment  could  probably 
be  reinvested  for). 

1307.  At  a  time  that  $1000  sums  of  the  given  grade  net  6  per  cent, 
and  savings  banks,  which  furnish  the  best  investment  for  small 

sums,  pay  4  per  cent.,  the  N  of       N    should  be  .03  and  the  N  of 

S(l-7r pw>)  should  be  -02-    If  at  anV  time  tne  investor  will  make 
the  proper  substitutions  in  tlw  formula  to  suit  the  Gircumstances 


420  THE  MATHEMATICS  OF  BOND  VALUES 

of  the  time,  he  will  have  a  more  accurate  idea  of  what  his  security 
ought  to  net  him,  than  he  can  (jet  from  the  present  tables. 

1308.  A  defense  of  the  tables  has  been  set  up  to  the  effect  that 
an  issue  of  serial  bonds  might,  with  equal  justification,  be  said  not 
1<>  yield  the  given  net  rate,  because  on  maturity  it  might  not  be 
possible  to  invest  the  proceeds  of  each  bond  at  the  same  net  rate. 
Bui  the  writer  can  see  no  analogy  whatever  between  the  net  yield 
in  the  sinking  fund  and  in  the  serial  issue  since  it  is  the  denomina- 
tion of  the  interests  sums  which  causes  the  greatest  trouble,  and  the 
denomination  of  serial  bonds  is  ordinarily  the  same  as  the  "  1  "  in  the 

-: — ^r—  of  the  formula. 

(1  +  N)n 

1309.  As  already  stated,  practical  considerations,  to  our  mind, 
outweigh  the  theoretical  advantage  of  trying  to  maintain  a  truer 
net  interest  rate  for  "  N  "  in  the  coupon  member  of  the  formula. 
But  again,  although  the  objection,  in  actual  practice,  is  acknowl- 
edged, to  a  differentiation  of  the  two  "Ns,"  there  seems  to  be  no 
valid  defense  of  the  common  "  N  "  of  the  present  tables  in  the  state- 
ment that  if  we  figure  the  interest  on  the  coupons  at  the  same  as  the 
interest  on  the  principal,  then  "  it  has  been  earned."  Surely  it  is 
not  a  question  of  what  has  been  earned.  It  is  a  question  of  what 
should  be  earned ;  what  is  intended  to  be  earned.  The  whole  func- 
tion of  the  bond  tables  is  to  approximate  the  facts  in  justice  to  both 
lender  and  borrower.  And  the  facts  concerning  the  rental  value  of 
investment  money  do  not  correspond  with  the  tables  as  well  as  one 
could  wish. 

1310.  Another  virtue  of  this  formula  is  the  clearness  with  which 
it  shows  how  to  figure  the  cost  or  net  yield  of  a  bond  which  must 
be,  or  has  been,  redeemed  at  a  premium.  The  bond  tables  do  not, 
of  course,  show  this.  If  a  bond  must  be  redeemed  at  110,1  the 
present  worth  of  the  principal  is  greater,  but  the  present  worth  of 
the  coupons  is  not  changed.     In  a  $1  bond  the 


^-(TTnt+nO   (TTn)») 


the  bond.  im 


Likewise  if  a  $1  bond  costing  94  has  been  called  at  102|,  what  it 
has  netted  will  be  found  in  the  same  way, — C  and  n  being  given  in 

(1  +  N)n     N\       (1  +  N)n  / 

1311.    Based  on  the  principles  of  the  first  formula  it  is  possible 
to  find  the  price  of  a  bond  without  reference  to  the  formula  or  the 

1  See  §  1269,  and  note. 


THE  MATHEMATICS  OF  BOND  VALUES      421 

bond  tables,  providing  there  are  at  hand  tables  of  present  worth. 
For  then  it  is  merely  necessary  to  find  the  present  worth  of  an 
annuity  of  f  1  for  the  given  interval  and  duration,  and  at  the  given 
rate,  and  to  multiply  this  by  the  number  of  dollars  cash  interest. 
To  the  result  must  be  added  the  present  worth  of  fl  principal, 
multiplied  by  1000  or  whatever  may  be  the  number  of  dollars  prin- 
cipal returnable  at  maturity. 

1312.  A  Second  Bond  Value  Formula.  There  are  other  ways  of 
deriving  bond  formulas ;  but  that  which  gives  the  simplest  algebraic 
result  is  based  on  the  fact  that  the  cost  of  the  bond  equals  the 
principal  or  par  value  plus  the  premium  or  minus  the  discount.  In 
the  case  of  the  bond  bought  at  a  premium,  how  is  that  premium 
determined? 

Let  us  again  take  a  f  1  two-year  6  per  cent,  bond  netting  4  per 
cent.  The  amount  received  from  the  semi-annual  coupon  is  .03. 
But  the  amount  entitled  to  be  considered  as  income  is  only  .02. 
Therefore  the  difference,  or  .01,  is  a  semi-annual  annuity,  the  present 
worth  of  which,  when  compounded  according  to  the  tables  at  the 
net  rate,  is  the  same  thing  as  the  premium. 

By  the  formula  already  derived,  the  present  worth  of  the  coupon 

amount  is     ^  A-  n  j  ;  but    since,    in    a    premium    bond    we 

seek  the  present  worth,  not  of  C,  but  of  C — N,  the  formula  for  the 

C— N  /  1        \ 

premium  will  be      -^—  fl-  (1  ,  N)n  J.       Adding  par  to  this  to  get 

the  present  worth  of  the  premium  bond,  we  have 


C— N 
Cost=lH — ==— 
N 


I1  (i+Nr) 


In  the  case  of  the  discount  bond  the  net  yield  is  more  than  the 
coupon  return.    The  formula  for  a  discount  bond,  therefore,  is 

Cost=l-^(l-(T^N-)n) 

It  will  be  seen  that,  even  more  easily  than  by  the  first  formula, 
the  cost  of  a  bond  may  be  found  from  annuity  tables  by  the  prin- 
ciples of  this  formula.1 

1313.  The  Application  of  the  Bond  Formulas.  The  application  of 
the  first  formula  to  conditions  under  which  the  tables  would  not 

1  For  an  example  of  a  formula  derived  on  entirely  different  lines,  see  Invest- 
ment Laws,  Albert  Hale,  Boston.     (Out  of  print.) 


422  THE  MATHEMATICS  OF  BOND  VALUES 

apply  has  been  illustrated  in  §  1310.  The  application  to  the  bond 
tables  themselves  is  very  easily  made.  To  avoid  the  use  of  loga- 
rithms, a  brief  duration  is  desirable.  According  to  the  tables  the 
cost  or  present  worth  of  a  5  per  cent,  bond  running  for  a  year  and 
a  half  and  netting  4  per  cent,  will  be  101.44,  or  $1014.40.  This  price, 
it  will  be  remembered,  is  a  decimal  approximation  correct  to  two 
places,  or  to  within  10  cents  on  a  $1000  bond.  According  to  the 
first  formula  in  its  shortest  form 

n    .  *i  k     a     N+C(l+N)»-C 
Co.t  $1  bond=       N(1  +  N)n 

_.02-+.025  (1.02)8-.025 
~  .02(1.02)3 

.0215302 


.02122416 


=1.01442.... 
Cost  $1000  bond=      1014.42 

It  will  be  seen  that  the  price  obtained  by  the  formula  corrects  a 
2-cent  error  in  the  tables,  due  to  decimal  approximation. 

1314.  The  Application  of  Bank  Discount  to  Bond  Transactions.  He 
who  buys  bonds  is  paid  interest,  usually  at  the  end  of  each  six 
months'  period.  If  he  were  paid  this  interest  in  advance  it  would 
be  more  profitable  to  lend  to  an  issuing  company  by  buying  its 
bonds,  because  whatever  interest  is  already  returned  is  sure;  and 
then  again  the  lender  (the  buyer)  could  have  this  money  to  let  out  at 
interest,  as  everybody  knows;  but  still  further,  the  lender  would 
not  have  to  lose  the  interest  on  the  interest  accrued  to  the  nominal 
buying  price,  as  few  people  realize. 

1315.  Therefore  the  banks,  which  are  constant  lenders  of  money, 
and  have  to  figure  more  closely  than  private  investors,  sometimes 
insist  on  buying  short  term  interest-bearing  loans,  like  town  notes, 
as  they  buy  commercial  paper;  not  at  a  "  basis  price,"  and  interest, 
in  accordance  with  the  bond  tables  and  formulas,  but  by  bank 
discount. 

1316.  Another  reason  why  banks  often  prefer  to  purchase  short 
loans  by  bank  discount  (hereafter  called  discount)  is  that  commer- 
cial paper  is  their  chief  medium  of  short  investment,  and  for  pur- 
poses of  comparison  of  rates,  and  pursuant  to  habit,  they  think 
best  in  terms  of  discount. 

1317.  The  mathematical  gain  by  discount  is  explained  as  follows: 
(a)   At  a  basis  price  the  money  invested  earns  interest  on  itself 


THE  MATHEMATICS  OF  BOND  VALUES  423 

at  the  given  rate;  (b)  but  at  discount  the  money  invested  earns 
interest  on  itself,  plus  the  interest  on  the  discount;  or  what  is  the 
same  thing,  (c)  at  discount  the  money  invested  earns  interest  on 
itself,  plus  the  difference  between  the  basis  and  the  discount  prices, 
plus  the  interest  on  this  difference  at  the  given  rate. 
Take  $1000  for  two  months  at  6  per  cent. 

At  Basis  At  Discount 

1000.00  Principal 
10.00  Discount 


990.00  Discount  Price 

(a)     990.099  Basis  Price  (b)   990.00  Discount  Price 

9.901  Interest  9.90  Interest 


1000.000  Principal  999.90 


.10  Interest   gained   on   the 
discount 


1000.00  Principal 

or  (c)  990.00  Discount  Price 
9.90  Interest 


999.90 

.099  Difference  bet.  basis  and 
discount  prices. 

.001  Interest  on  this  differ- 
ence. 


1000.000  Principal 

From  (b),  the  interest  gained  on  the  discount  =.10 

From  (c),  the  difference  between  the  two  prices,    .099 
plus  the  interest  on  this  difference,        .001 


=.10 

1318.  The  Difference  Between  Discount  Price  and  Basis  Price  for 
Bonds  Maturing  Within  Six  Months,  and  the  Total  Ultimate  Gain.  It 
will  often  be  of  interest  to  know  just  the  amount  the  lender  gains 


424  THi:  MATHEMATICS  OF  BOND  VALUES 

by  bank  discount, — particularly  on  short  loans  falling  within  a 
six-months'  period.  Suppose  a  G  per  cent,  bond  having  six  months 
to  run,  discounted  at  4  per  cent,  in  the  one  case,  and  priced  to  net 
1  per  cent,  in  the  other: 

The  principal  sum    1000.00 

The  coupon  30.00 

The  total  principal  1030.00 

The  discount  (6  mos.  at  4  per  cent.) 20.60 

Discount  price  of  the  bond 1009.40 

Basis  price  of  the  bond  1009.80 


Price  gain  at  the  time  of  purchase,  by  discounting.  . .  .40 

Interest  gained  during  6  mos.  at  4$  on  gain  of  .40. . . .  .01 

Total  ultimate  gain  .41 

1319.  Sometimes  a  quicker  way  to  arrive  at  the  proceeds  $1009.40 
will  be  to  take  98  per  cent,  of  $1030  immediately. 

If  the  bond  had  been  bought  on  basis,  between  interest  intervals, 
so  that  interest  would  have  accrued,  the  real  gain  by  discount  would 
have  been  slightly  greater. 

1320.  To  Discount  a  Bond  Having  Two  or  More  Coupons  Attached: 
i.e.  Running  Over  Six  Months.  In  business  one  would  never  be  called 
upon  to  discount  a  bond  running  longer  than  a  year,  and  only  rarely 
one  running  beyond  six  months.  Suppose,  however,  as  before  a  6 
per  cent,  bond  discounted  at  4  per  cent.,  against  a  bond  to  net  4  per 
cent.,  but  having  nine  months  to  run.  For  clearness,  the  purchase 
of  the  bond  at  discount  may  be  looked  upon  as  the  purchase  of  one 
note  (or  coupon)  of  $30,  discounted  at  4  per  cent,  for  three  months, 
and  of  another  note  (principal  sum  plus  the  other  coupon)  of 
$1030  discounted  at  4  per  cent,  for  nine  months: 

Proceeds  of  coupon 29.70 

Proceeds  of  principal  plus  coupon 999.10 


Proceeds  or  bank  discount  price  of  note 1028.80 


THE  MATHEMATICS  OF  BOND  VALUES  425 

1321.  The  Theoretical  Gain  by  Buying  at  Discount  Rather  Than  at 
Basis,  on  a  Bond  Running  Over  Six  Months,  but  not  Bought  on  an 
Interest  Date: 

Basis  price  of  the  above  bond 1014.60 

Interest  accrued  for  three  months 15.00 

Total  basis  cost  or  flat  price  at  purchase 1029.60 

Discount  price  of  bond  as  already  found 1028.80 


Net  gain  by  discount  method  at  purchase .80 

Since  the  basis  cost  ($1029.60)  and  the  discount  cost  ($1028.80) 
will  ultimately  yield  the  same  sums,  namely  $30  in  three  months 
and  $1030  in  nine  months,  the  ultimate  gain  by  the  discount 
method  will  be  the  80  cents  difference  in  cost  plus  whatever 
the  80  cents  will  earn  at  say  4  per  cent,  for  the  nine  months  com- 
pounded theoretically  at  the  end  of  three  months,  when  the  coupon 
interest  is  paid, — or  in  all,  82  cents. 


CHAPTER  XXXV 
THE  USE  OF  THE  BOND  TABLES 

1322.  The  bond  tables,  based  on  the  principles  of  the  formulas, 
are  constructed  to  show  the  cost,  within  at  least  a  cent  on  f  100,  of 
a  bond  bearing  interest  at  most  of  the  following  rates :  2,  2|,  3,  3£, 
3.65,1  4,  4^,  5,  6,  and  7  per  cent.,  and  netting  from  2  to  7  per  cent. 
Since  there  is  a  much  greater  number  of  "  net  yields  "  it  is  de- 
sirable to  know,  than  of  interest  rates  that  bonds  ordinarily  bear, 
the  length  of  the  page  is  usually  given  to  the  net  yield,  which  is 
sometimes  graded  by  eighths,  such  as  2,  2&,  2£,  etc.,  sometimes  by 
tenths,  and  even  by  twentieths.  In  the  subjoined  sample  page  of  a 
commonly  used  book  of  bond  tables,2  one-tenth  per  cent,  divisions 
have  been  combined  with  one-eighth  and  one-twentieth. 

1323.  It  will  be  seen  that  all  but  one  of  the  Factors  of  Net 
Return  are  to  be  found  on  the  page.  Premium  and  discount  are  in- 
dicated in  columns  of  value.  The  nominal  interest  rates  are  at 
the  heads  of  the  columns,  and  the  effective  interest  rates  or  net 
yields,  at  the  side.  The  duration  (20  years)  is  from  the  day  the  bond 
is  purchased  until  its  maturity.  The  tables  are  computed  usually 
for  semi-annual  durations  from  6  months  to  25  or  30  years,  and 
annually  from  then  to  50  years,  and,  if  carried  further,  by  lustra, 
or  five-year  periods,  to  100  years.  The  interest  interval,  however,  is 
not  indicated  except  on  the  title  page.  In  this  table  it  is,  of  course, 
a  six-months'  period. 

1324.  Accrued  Interest.  The  table  as  it  stands  is  accurate  to 
within  10  cents  on  $1000  bond,  for  a  duration  of  exactly  20  years. 
For  greater  accuracy  the  extended  bond  tables,  correct  to  the  near- 
est cent  on  a  $1,00(1,000  bond,  should  be  used.  No  cashier  should  con- 
tent himself  with  the  briefer  tables,  even  though  they  suffice  for  ordi- 
nary commercial  transactions.  If,  as  is  probable,  the  bond  was 
not  bought  on  the  exact  interest  date,  to  the  price  indicated  in  the 

1  As  to  the  reason  for  this  irregular  rate,  v.  §1346. 

2  Bond    Values,   Montgomery    Rollins,   Boston,    Fourteenth   Edition. 

426 


THE  USE  OF  THE  BOND  TABLES 


427 


20  YEARS. 

Interest  Payable  Semi- Annually. 


PERCENT 
PER  AN. 


2.90 

3. 

3.10 

3M 

3.20 

SK 

3.30 

3.35 

3K 

3.40 

3.45 

3l4 

3.55 

3.60 

S% 

3.65 

3.  TO 

3% 

3.80 

3% 

3.90 

4. 

4.10 

4% 
4.20 

4H 
4.30 
4K 
4.40 

4^i 
4.60 

4% 

4.70 

1? 

5. 
6.10 

5^20 

6.30 

BM 

5.40 

5M 
5% 
5^ 
5jf 
6. 


3% 


101.51 
100.00 
98.52 
98.15 
97.06 
96.34 

95-63 
94.93 

94-53 
94.23 

93-54 
92.85 
92.17 
91.50 
91.16 
90.83 
90.17 
89.51 
88.86 
87.90 
87.58 
86.32 
85.09 
84.78 
83.87 
83.27 
82. 68 
81.80 
81.51 
80.35 
79.22 
78.94 
78.11 
77.57 
77.02 
76.22 

75-95 
74.90 
73-86 
73.61 
72.85 
72.34 

71.85 
71.11 
70.87 
69.90 
68.72 
67.57 

66.43 
65.33 


Vi% 


109.06 
107.48 

105.93 
105.55 
104.41 
103.66 
102.91 
102.17 
101.81 
101.44 
100.72 
100.00 

99.29 

98.58 
98.23 

97.88 

97-*9 

96.50 

95.82 
94.81 
94.48 
93.16 
91.86 
91.54 

90.59 
89.96 

89-34 

88.42 

88.11 
86.90 
85.72 

85.42 

84-55 

83.98 
83.40 
82.56 
82.28 
81.17 
80.09 
79.82 

?g.02 
8.49 

77-97 
77.19 
76.94 
75.92 
74.68 
73.46 

?2.27 
1.11 


I16.60 

114.96 

"3-34 
112.94 

"1-75 
110.97 
no. 19 
109.42 
109.04 
108.66 
107.90 
107.15 
106.41 
105.67 
105.30 
104.94 
104.21 
103.50 
102.78 
101.73 
101.38 
100.00 
9S.64 
98.31 

97-31 
96.65 
96.00 
95.04 
94.72 
93.45 
92.21 
91.90 
90.99 
90.39 

89.79 
88.90 
88.61 
87.45 
86.31 
86.03 
85.19 
84.64 
84.09 
83.27 
83.01 
81.94 
80.64 
79.36 
78.  XI 
76.89 


&% 


124.15 
122.44 
120.75 
120.33 
119.09 
118.28 
117.47 
116.66 
116.27 
115.87 
115.08 
114.30 
"3.52 
112.75 
112.37 
111.99 
in. 24 
110.49 
109.74 
108.64 
108.28 
106.84 
105.42 
105.07 
104.03 
103.35 
102.66 
101.65 
101.32 
100.00 
98.70 
98.38 

97-43 
96.80 
96.17 
95.24 

94-94 
93.72 

92.53 
92.24 

91.36 

90.78 
90.21 
89.36 
89.07 
87.96 
86.59 
85.26 

8395 
82.66 


131.70 
129.92 
128.16 
127.73 
126.44 
125.59 

124.75 
123.91 
123.49 
123.08 
122.26 
121.45 
120.64 
119.84 
119.44 
119.04 
118.26 
117.48 
116.70 
115.56 
115-18 
113.68 
112.20 
111.84 
110.75 
110.04 

109.33 

108.27 

107.93 

106.55 
105.19 
104.86 
103.86 
103.20 
102.55 
101.59 
101.27 
100.00 
98.76 
98.45 

97-53 
96.93 

96.33 
95.44 

95-14 

93.98 

92-55 
91.15 

89.78 
88.44 


46.80 
44.87 
42.98 
42.52 

41.13 
40.21 

39-30 

38.40 

37-95 
37.51 
36.62 
35.74 

34-87 
34.01 

33.58 
33.15 
32.30 
31.46 
30.63 
29.39 
28.98 
27.36 
25.76 
25.37 
24.19 
23.42 
22.65 
21.51 
21.14 
19.65 
18.18 
17.82 
16.74 
16.02 
15-32 
14.27 
13.92 
12.55 
11.20 
10.87 
09.87 
09.22 

08.57 
07.60 
07.28 
06.02 

04.47 
02.95 
01.46 
00.00 


7% 


61.89 
59.83 
57-8i 
57.31 
55.82 
54.83 
53-86 
52.89 

52.41 
51.93 
50.98 
50.04 
49.H 
48.18 

47-72 
47.26 

46.35 
45.44 

44-55 
43.22 
42.78 
41.03 

39-32 
38.90 

37.63 
36.80 

35.98 
34.75 

34-35 
32.74 

31.16 
30.77 
29.61 
28.84 
28.08 
26.95 
26.58 
25.10 

2365 
23.29 
22.22 
21.51 
20.81 
19.77 
19.42 
18.06 
16.38 
14.74 

13-13 

11.56 


lis        THE  USE  OF  THE  BOND  TABLES 

table  must  be  added  "accrued  interest"  from  the  last  interest  date 
to  the  day  of  purchasing;  and  this  accrued  interest,  figured  from  any 
book  of  aliquot  interest  tables,  will  be  at  the  rate  of  interest  the 
coupon  bears,  since  "  accrued  interest "  serves  to  reimburse  the 
seller  for  the  bond  interest  which  he  has  earned  up  to  the  date 
payment  is  made,  and  which  is  paid  back  to  the  buyer  in  the  coupon 
interest  at  the  next  interest  date. 

1325.  In  accordance  with  resolutions  recently  passed  by  New 
York  bankers  in  convention,  and  with  the  rules  of  the  New  York 
Stock  Exchange  for  dealing  in  interest-paying  bonds  on  their  board, 
adopted  December  23d,  1908 : — contracts  made  after  default  in  pay- 
ment of  interest,  and  during  continuance  of  default,  are  to  be 
"Flat"  (i.e.  without  accrued  interest).  Interest  at  the  rate  speci- 
fied in  an  interest-bearing  bond  must  be  computed  on  the  basis  of 
a  360-day  year,  i.e.  every  calendar  month  is  one-twelfth  of  300 
days,  or  30  days ;  every  period  from  a  date  in  month  to  the  same  date 
in  the  following  month  is  30  days.  February,  therefore,  is  taken  as 
a  30-day  month.  Income  bonds  must  be  dealt  in  "  Flat."  Except 
as  mentioned,  bonds  on  the  New  York  Stock  Exchange  and  among 
brokers  generally,  are  now  quoted  at  a  price  "  and  interest." 

1326.  Suppose  a  20-year  7  per  cent,  bond  paying  interest 
Jan.  and  July  1,  is  bought  April  26  for  delivery  April  27 
at  115  and  accrued  interest.  In  addition  to  the  $1150  cost  as 
of  Jan.  1  there  must  be  added  $22.56,  which  any  book  of  360-day 
interest  tables  will  show  has  accrued  on  $1000  at  7  per  cent,  for 
the  3  months  26  days  elapsed  since  Jan.  1.  The  total  cost,  there- 
fore, as  accepted  by  financial  houses,  will  be  $1172.56. 

1327.  The  buyer  sometimes  objects  to  paying  accrued  interest, 
usually  because  he  does  not  see  at  first  how  he  will  be  reimbursed 
for  the  accrued  interest  outlay.  We  know  of  sales  which  have 
been  lost  because  the  prospective  buyer  thought  the  interest 
accumulation  would  alter  materially  the  basis  of  net  return  upon 
the  investment.  He  will  be  repaid  the  $22.56  on  July  1,  or  in  64 
days,  when  the  next  coupon  of  $35  is  cashed;  and  the  difference 
of  $12.44  between  the  coupon  and  the  accrued  interest  reimburse- 
ment, is,  of  course,  the  interest  at  7  per  cent,  on  $1000  for  64 
days  to  which  he  is  entitled  by  ownership. 

1328.  A  more  defensible  objection  to  the  arrangement  of 
accrued  interest  as  it  is  figured  might  be  raised  on  the  ground 
that  the  buyer  loses  the  use  of  the  accrued  interest  from  the  time 
of  purchase  until  he  regains  it  at  the  next  interest  period.     This 


THE  USE  OF  THE  BOND  TABLES         429 

slight  loss  of  interest  on  the  accrued  interest  should  be  reckoned 
at  the  current  savings  bank  rate,  and  the  time  should  be  reckoned, 
like  bank  interest  time,  with  365  days  to  the  year,  rather  than 
like  bond  interest  time,  with  360  days. 

1329.  The  loss  at  4  per  cent,  on  22.56  for  64  days  would  be 
approximately  .16  and  would  probably  be  collectible  at  law  from 
the  seller.  Since  a  variation  of  one  point  in  the  second  decimal 
of  the  current  bond  tables  is  equivalent  to  a  variation  of  10  cents 
in  price,  the  corrected  cost  of  this  bond  would  be  115.02  and  in- 
terest. But  the  difference  of  .02  in  price  is  too  small  to  change  the 
basis  of  net  return  at  the  second  decimal,  except  for  loans  of 
brief  duration. 

1330.  Although  "  price  and  interest "  is  the  usual  way  of  sell- 
ing bonds,  sometimes  the  interest  is  added  to  the  basis  cost  and 
the  bond  sold  at  a  "  flat  price."  Flat  price  in  this  case,  then, 
means  interest  included.  Flat  price  in  the  Stock  Exchange  ruling 
above  in  reference  to  defaulted  and  income  bonds,  means  "  with- 
out accrued  interest," — quite  a  different  thing.  This  double  use 
of  flat  price  is  quite  confusing  but  general. 

1331.  Bond  Issues  of  One  Fixed  Duration.  Having  disposed  of 
these  preliminary  matters,  we  can  canvas  the  uses  of  the  bond  tables 
under  all  conditions,  with  this  20-year  page  for  the  purpose.  First 
let  us  assume  that  the  issue  is  not  callable,  or  redeemable  at  all, 
prior  to  the  date  regularly  set  for  payment. 

1332.  To  Find  tJw  Net  Yield  at  a  Tabulated  Price  is  seldom  the 
object,  because  such  a  small  proportion  of  all  possible  prices  can 
be  set  in  the  tables.  Such  price  must  be  in  the  perpendicular 
column  corresponding  with  the  coupon  rate  of  the  bond.  The  rate 
per  cent,  per  annum  in  the  extreme  left  column  on  the  same  hori- 
zontal line  will  be  the  net  yield  at  the  price. 

1333.  To  Find  the  Price  at  a  Tabulated  Net  Yield  is  a  most 
common  requirement  because  the  ultimate  determination  of  price  is 
net  yield,  and  most  of  the  convenient  and  generally  used  decimal 
and  fractional  intervals  between  any  per  cent,  and  the  next  are  to 
be  found  in  the  tables.  Find  the  tabulated  net  yield  in  the  extreme 
left  column.  The  price  along  the  horizontal  line  in  the  perpendicular 
column  bearing  the  same  coupon  rate  as  the  issue,  will  be  the 
proper  price.  But  since  the  shorter  tables  are  based  on  bonds  of  $100 
denomination,  the  price  will  be  multiplied  by  10  for  a  $1000  bond. 
This  multiplication  by  10  without  a  third  correcting  decimal  is  the 
cause  of  a  possible  inaccuracy  of  as  much  as  9  cents  a  bond.    For 


430        THE  USE  OF  THE  BOND  TABLES 

this  reason  those  who  deal  frequently  or  in  large  amounts  should 
be  at  least  familiar  with  the  extended  tables. 

1334.  Untabulated  Figures :  Interpolation.  To  Find  the  Net  Yield 
at  an  Untabulated  Price.  From  this  point  we  deal  with  the  com- 
moner situation  in  which  the  given  figures  have  no  identical  cor- 
respondent in  the  tables.  The  net  yield  or  price  sought  will  be  found 
between  two  figures  in  the  tables, — generally  adjacent.  Therefore 
the  process  of  finding  the  untabulated  figure  is  a  process  of  Inter- 
polation. 

1335.  What  will  be  the  net  return  of  a  6  per  cent.  20-year  bond 
(with  20  years  to  run  from  date  of  purchase)  selling  at  125?  In 
the  6  per  cent,  column  125  lies  between  125.37  and  124.19.  125.37 
is  a  4£  per  cent,  basis  and  124.19  is  a  4.20  basis.  The  net  return  of 
125  must  be  somewhere  between  4^  and  4.20  per  cent.,  but  nearer 
4i ;  or  expressing  both  rates  by  decimals  only,  between  4.125  and 
4.200  per  cent. 

1336.  There  is  no  direct  mathematical  process  by  which  this  yield 
can  be  determined  with  exactness;  but  there  are  two  methods  of 
approximation,  the  first  of  which,  called  the  method  of  proportion, 
can  be  more  easily  understood  and  applied,  and  suffices  for  most 
purposes.     It  may  be  expressed  almost  graphically: 

Difference  Yield  Price  Difference 

37 


4.125     = 

=     125.37 

x        = 

=     125.00 

4.200     = 

=     124.19 

t 


.81 


.075  1.18 

37 

-X.075=.024 


1.18 

4.125+. 024=4.149  or  4.15 

1337.  The  simple  presentation  is  easier  of  understanding  than  the 
formal  statement,  which  is  as  follows :  Since  the  lower  the  price  the 
higher  the  net  return,  an  intermediate  rate  of  yield  will  be  nu- 
merically distant  from  its  adjacent  rates  in  approximately  the  same 
ratio  that  the  intermediate  price  is  distant  from  its  adjacent  prices. 

Let  x=the  unknown  yield.  The  difference  between  x  and  4.125 
will  bear  approximately  the  same  relation  to  the  total  income  varia- 


THE  USE  OF  THE  BOND  TABLES  431 

tion  of  .075  that  the  price  difference  of  .37  bears  to  the  total  price 
variation  of  1.18. 

X -4.125     .37 
.075      ~1.18 

X-4.125=;-^X.075=.024 

X=4.149  or  4.15 

1338.  A  variation  of  this  first  method  shortens  the  computations, 
but  inclines  to  be  slightly  less  accurate,  because  price  differences 
lessen  as  prices  approach  par.  If  instead  of  taking  the  net  yield 
corresponding  to  the  nearest  price  above,  i.e.  125.00,  we  had  taken 
the  yield  that  was  .10  less  than  4.20,  the  process  would  have  been 
simplified  as  follows: 

Difference  Yield  Price  Difference 

4.10  =  125.76  l  .76 

x  =  125.00  j 

4.20  =  124.19  [  -81 


.10 1.57 

-^-X  .10=.048 
1.57 

4.10+.048=4.148  or  4.15 

1339.  The  second  method,  contrived  by  Mr.  Charles  E.  Sprague, 
is  a  method  of  gradual  approximation.  The  text  of  Mr.  Sprague's 
explanation  is  as  follows : 

"  Let  us  give  the  name  of  trial  divisor  to  the  difference  between  the  values  of  a 
4  per  cent,  and  a  5  per  cent,  bond  on  the  same  basis  and  for  the  same  time  ;  or,  what 
is  the  same  thing,  between  a  5  per  cent,  and  a  6  per  cent.;  always  1  per  cent,  differ- 
ence in  the  nominal  rates. 

"Assume  arbitrarily  for  trial  any  income  rate;  the  nearer  the  true  rate,  as  indicated 
by  the  tables,  the  less  the  work  of  approximation.  Find  the  trial  divisor  at  this 
trial  rate.  Divide  the  given  premium  (or  discount)  by  this  trial  divisor.  The  quo- 
tient is  to  be  subtracted  from  the  nominal  rate  if  the  bond  isebove  par,  or  added  to 
it  if  below  par ;  the  result  will  be  an  approximate  rate  which  will  be  nearer  the 
truth  than  the  trial  rate,  being  too  great  when  the  trial  rate  is  too  small,  and  vice 
versa  This  approximate  may  be  used  as  a  new  trial  rale,  and  will  result  in  a  still 
closer  approximation." 

1340.  In  the  6  per  cent.  20-year  bond  cited  above  as  selling  at  125, 
it  is  given  to  find  the  net  yield.  In  the  20-year  6  per  cent,  column 
start  with  4.20 — too  large,  but  the  basis  for  a  trial  divisor. 


432        THE  USE  OF  THE  BOND  TABLES 

A  20-year  0  per  cent,  bond  on  a  4.20  basis  is  worth.  . .  .   124.19 
A  20  year  7  per  cent,  bond  on  a  4.20  basis  is  worth. . .  .  137.63 


Therefore  the  trial  divisor  is 13.44 

25  -=-  13.44=1.86  6—1.86=4.14 

4.14  is  too  small,  but  the  basis  for  a  new  trial  divisor. 
The  trial  divisor  of  4.20=13.44 

4.14=    x 

4.10=13.56  (From  the  tables.) 

By  proportion  the  trial  divisor  of  4.14=13.51 
25    -4-  13.51=1.85  6—1.85=4.15 

4.15  is  too  great,  but  the  basis  of  a  new  trial  divisor. 
The  trial  divisor  of  4.15  is  13.50. 

25    -=-13.50=1.852  6—1.852=4.148 

4.148  is  too  small,  and  4.15  is  too  great,  but  the  net  yield  is  found 
to  two  decimals,  and  agrees  with  the  result  found  from  the  method  of 
approximation  by  proportion.  4.15  is  approximately  the  net  yield  of 
a  20-year  6  per  cent,  bond  at  125. 

1341.  To  Find  the  Net  Yield  at  a  Flat  Price  is  a  problem  of  like 
nature  to  the  previous.  Since  flat  price  for  undefaulted  bonds 
means  price  with  interest  accrued,  and  accrued  interest  is  never 
taken  into  consideration,  commercially,  in  reckoning  interest  yield, 
the  procedure  is  to  subtract  the  interest  accumulation  to  find  the 
"  price  and  interest,"  and  continue  as  before. 

1342.  Because  bonds  in  default  are  sold  flat  they  may  reach  a 
high  premium  if  the  prospect  is  bright  that  overdue  coupons  will 
soon  be  honored.  Obviously  the  return  may  be  no  such  low  rate  as 
the  premium  at  first  glance  might  suggest.  But  it  cannot  be  com- 
puted until  the  time  of  delayed  coupon  payment  is  made  known. 
Then  it  will  most  easily  be  found  by  substitution  in  the  first 
formula. 

1343.  To  Find  the  Price  at  an  Untdbulated  Net  Yield  calls  for 
I  he  interpolation  by  proportion  of  a  price  between  two  others  in  the 
lahlcs.  r>v  the  semi -graphic  method  employed  before  it  is  easily 
expressed  for  the  20-year  6  per  cent,  bond  as  follows:  At  what 
] tr ice  (for  instance)  does  the  above  bond  net  4.15  per  cent.? 

Difference 
.10 


Yield 

Price 

Difference 

4.10 

— 

125.76 

4.15 

X 

1.57 

4.20 

__, 

124.19 

THE  USE  OF  THE  BOND  TABLES        433 

Rate  difference  of  .10=1.57  of  price  difference 
Rate  difference  of  .05=.785  of  price  difference 
125.76— .785=124.975=124.98 

1344.  It  will  occur  to  many  that  simple  proportion  may  not  al- 
ways be  accurate,  even  to  the  two  decimal  places  of  the  tables.  This 
conclusion  will  be  reached  on  noting  in  the  20-year  page  that  the 
difference  in  price  of  a  6  per  cent,  bond  on  a  2.90  and  a  3.00  basis 
is  not  the  same  as  the  difference  between  the  prices  at  a  3.00  and  a 
3.10  per  cent,  basis.  The  former  difference  is  1.93  and  the  latter 
1.89.  A  careful  examination  of  many  similar  cases  will  show, 
among  premium  bonds,  that  the  higher  the  premium  the  greater  the 
difference ;  and  among  discount  bonds,  that  the  greater  the  discount 
the  less  the  difference ;  and  since  at  a  given  yield,  the  longer  the  loan 
the  greater  the  premium  or  discount,  the  greater  opportunity  for 
error  lies  in  computing  intermediate  proportion  in  long-term  loans. 
A  means  must  be  found  for  correcting  these  discrepancies  and  for 
ascertaining  how  short  the  maturities  for  which  correction  is  needed. 

1345.  Mr.  Sprague  has  ingeniously  devised  a  "  one-eighth  rule  " 
which  correctly  adjusts  the  error;  but,  so  far  as  the  writer  knows, 
no  one  has  explained  how  this  rule  is  derived. 

Because  the  error  is  greater  in  long  loans,  and  at  high  premiums, 
it  will  be  most  apparent  and  easy  of  correction  in,  say  a  100-year, 
5  per  cent.  bond.  It  will  be  greater,  also,  when  the  interpolated 
yield  is  the  furthest  possible  (.05)  from  the  nearest  tabulated  yield. 

In  the  excerpt  below,  from  the  100-year  page  of  the  tables,  the 
"  2d  difference  "  is  obtained  by  subtraction  in  the  column  of  the 
"  1st  difference." 

To  correct  the  price  of  a  2.75  per  cent,  yield  found  by  proportion : 


Basis 

Price                              1st  Difference 

2d  Difference 

(large) 

2.70 

=     179.36                                     1 

■ 

(small) 

2.75 

=     176.53   (by  proportion)      I  5.66 

(large) 

2.75 

=     176.49  (by  the  table) 

►.31 

(large) 
(large) 

2.80 
2.90 

=     173.70                                   ) 

[  5.35 
=     168.35                                  ) 

-. 

The  first  column  of  differences  shows  that  the  rate  of  difference 
changes  materially  between  each  .10  per  cent,  of  the  income  bases; 
and  the  second  column  of  differences  shows  what  the  rate  of 
change  is.    Since  in  this  case  we  have  the  price  at  a  2.75  basis,  not 


1  :i        THE  USE  OF  THE  BOND  TABLES 

only  by  proportion,  but  by  the  tables, — it  remains  only  to  establish 
some  approximate  relation  between  the  discrepancy  176.53 — 176.49, 
and  the  rate  of  change  in  each  .10  per  cent  of  basis  (.31)  to  have  a 
method  for  correcting  the  error  in  simple  proportion. 

176.53— 176.49=.04=£  of  .31,  approximately. 

Hence  the  rule:  Whether  above  par  or  below,  subtract  one-eighth 
of  the  second  difference  from  the  approximate  value  of  the  propor- 
tion to  find  the  true  value. 

In  order  to  make  a  correction  the  second  difference  must  be  more 
than  .04,  so  that  one-eighth  of  it,  when  "  rounded  off,"  will  equal  .01 
or  more, — to  be  subtracted  from  the  price  obtained  by  proportion. 
Occasional  second  differences  of  .05  will  be  found  in  the  ordinary 
tables  as  early  as  the  22d  year,  and  the  test  should  therefore  be 
applied  from  the  22d  year  on, — that  is  for  bonds  running  for  22 
years  or  more. 

1346.  To  Find  the  Net  Yield  at  an  Untabulated  Coupon  Rate.  By 
the  laws  of  some  states  (such  as  those  requiring  all  bonds  to  be  sold 
at  par  or  above)  it  is  sometimes  necessary  for  the  smaller  mu- 
nicipalities to  issue  bonds  at  unusual  rates  of  interest.  On  other 
grounds  3.65  per  cent,  (one  cent  a  day  on  $100)  is  an  odd  coupon 
rate  of  sufficient  vogue  and  long  standing  to  have  obtained  a  place 
in  some  tables.  All  such  untabulated  rates  may  be  approximated 
by  proportion. 

To  find  the  net  yield  of  a  20-year  3.35  per  cent,  bond  at  72. 


Difference 

Coupon  Rate 

Net  Yield 

Difference 

.35 

i  3.00         = 
j  3.35         = 
|  3.50        = 

5.28 

1 

X 

I    .62 

.15 

5.90 

J 

.50 

.35 

.50   X-62= 

=.43 

5.28+.43= 

=5.71 

That  results  like  this  are  only  approximate  is  settled  by  reversing 
the  process.  A  20-year  3.35  per  cent,  bond  on  a  5.71  basis  gives  by 
proportion  the  price  72.08  instead  of  the  price  72,  with  which  we 
started. 


THE  USE  OF  THE  BOND  TABLES  435 

1347.  To  Find  the  Price  at  an  Untabulated  Coupon  Rate.  From 
the  second  bond  formula,  we  know  that  a  premium  or  discount  may 
be  looked  upon  as  a  "  sinking  fund  "  to  amortize,  or  accumulate, 
the  difference  between  the  coupon  rate  and  the  net  rate;  and  that 
at  maturity  the  fund  so  collected  will  equal  the  premium  or  dis- 
count. 

The  difference  between  a  cash  rate  of  5  per  cent,  and  a  net  rate 
of  4  per  cent,  is  $10  per  bond ;  and  between  a  cash  rate  of  6  per  cent, 
and  a  net  rate  of  4  per  cent,  is  $20 ;  and  between  7  per  cent,  and  4 
per  cent,  is  $30,  etc.  Therefore  the  premium,  or  discount,  or  price, 
increases  in  arithmetical  ratio  with  the  increase  in  cash  rate. 
Stated  more  generally,  the  price  of  a  bond,  at  any  net  rate,  and  at 
any  odd  coupon  or  cash  rate  may  be  exactly  ascertained  to  two 
decimals  by  proportion  with  the  prices  of  larger  and  smaller  coupon 
rates  at  the  same  net  yield.  Therefore  it  is  very  easy  to  find  the 
price  at  a  given  net  yield  of  the  municipal  4|s,  like  the  recent  New 
York   City   issues. 

1348.  In  proof,  read  the  20-year  table  from  left  to  right,  at  any 
income  basis.  At  4.70  net,  each  half  per  cent,  in  cash  rate  increases 
the  price  by  6.44,  and  1  per  cent,  increase  in  cash  rate  doubles  the 
increase  to  12.88;  except  that  the  increase  may  be  .01  less,  due  to 
the  rounding  of  the  last  decimal  in  the  price. 

To  find  the  price  of  a  20-year  9  per  cent,  bond  on  a  4.70  basis. 

Coupon  Rate  Price             Difference 

3#      =  78.11  [      38.e3 

%       =  116.74 

9#       =  x  [      38-63 

By  proportion  a  9  per  cent,  bond  on  a  4.70  basis=116.74-(-38.63= 
155.37.1 

1349.  This  is  a  more  accurate  ascertainment  of  the  price  than  to 
find  the  price  difference  between  6  and  7  per  cent.,  multiply  it  by 
2,  and  add  the  result  to  the  7  per  cent,  price  (which  would  give 
155.35),  since  the  loss  by  approximation,  in  rounding  the  second 
decimal  in  the  7  per  cent,  price,  is  doubled  when  multiplied  by  2. 

1  This  method  is  not  strictly  interpolation  (between  two  given  rates),  but 
rather  projection;  but,  as  the  principles  are  the  same,  we  call  attention  to  a  dis- 
tinction rather  than  a  difference. 


436  THE  USE  OF  THE  BOND  TABLES 

To  find  the  price  of  a  20-year  3.35  per  cent,  bond  on  a  4.70  per 
cent,  basis. 

Difference  Coupon  Rate  Price  Difference 

3.00     =     78.11 


.35 
.15 
.50 


i 


3.35     =       x  6.4^ 

3.50     =     84.55 


5-X6.44=4.51  78.11+4.51=82.62 


.50 

1350.  To  Find  the  Net  Yield  at  an  Untabulatcd  Duration.  Any 
bond  not  bought  on  an  interest  date  may  be  considered  as  having 
an  untabulated  duration. 

To  find  the  net  yield  of  a  7  per  cent,  bond  maturing  in  20  years, 
2  months,  and  15  days,  the  price  of  which  is  159.83. 


Duration  Net  Yield 

20  yrs.  =     3.00 

20  yrs.  1\  mos.  =         x 

20  yrs.  6  mos.  =     3.05 

-f  X-05=.02 


6 


3.00+.02=3.02 


1351.  Commercial  usage  goes  no  further  in  correcting  the  net 
yield  between  interest  periods;  but  in  short-time  loans  the  interest 
lost  on  the  accrued  interest  may  alter  the  yield  perceptibly,  as  al- 
ready noted. 

1352.  The  loss  on  a  $1000  bond  or  note  bearing  interest  at  3£ 
per  cent.,  bought  3  months  and  27  days  after  the  last  semi-annual 
interest  date,  is  8  cents,  or  approximately  .01  in  the  price  column. 
If  this  bond  or  note  matured  at  the  next  interest  date,  and  were 
sold  at  par  and  interest,  the  loss  in  interest  on  the  accrued  interest 
would  bring  the  cost  up  to  101  and  interest,  and  change  the  yield 
from  3.50  to  3.49.  Tantulum  suflicit!  This  is  one  reason  why  very 
short  term  loans  are  advantageously  bought  by  discount  rather  than 
as  interest-bearing. 


THE  USE  OF  THE  BOND  TABLES  437 

1353.  If  a  bond  runs  over  50  years  it  might  even  be  bought  on  an 
interest  date  and  yet  have  untabulated  duration,  since  the  tables 
ordinarily  give  prices  and  bases  only  at  5-year  intervals  for  terms 
longer  than  50  years.  But  this  lustral  variation  in  net  yield  admits 
correction  by  proportion. 

To  find  the  net  yield  of  a  98-year  5  per  cent,  bond  selling  at  220. 

Duration  Net  Yield 

100  years  =    2.11 

98  years  =       x 

95  years  =    2.09 


X-02=.01  (to  2  decimals) 


_2 
5 
2.11— .01=2.10 


1354.  To  Find  the  Price  at  an  Untabulated  Duration.  Since  only 
two  of  the  365  days  in  the  year  are  interest  dates  (for  most  bonds), 
and  the  price  at  a  given  yield  always  changes  radically  from  one 
semi-annual  period  to  the  next,  it  is  almost  always  necessary,  in 
finding  the  price  of  a  bond  at  a  given  net  yield,  to  adjust  it  to  the 
day  of  purchase.  This  is  done  by  proportion.  At  what  price  will  a 
bond  running  20  years,  4  months,  and  10  days,  net  4  per  cent.  ? 

Difference  Duration  Price 


4  1-3  mos.     \    20  JT^-  =     113.68 

j    20  yrs.  4  1-3  mos.     =  x 

1  2-3  mos.     |   20  1.2  yrg  _     113  90 


6  months 

li?-X-22=.16  (approx.) 
6 

113.68+.16=113.84 

Since  the  price  of  this  bond  varies  .22  in  180  days,  or  .01  in  about 
8  days,  or  10  cents  in  8  days  there  is  an  approximate  variation  of 
about  a  cent  a  day.  At  the  given  net  and  cash  bases  the  rate  of 
difference  in  price  over  a  number  of  years  is  so  constant  (not  varying 
over  .01  per  annum)  that  no  correction  of  the  method  of  proportion 
is  necessary,  within  an  interest  interval. 


438        THE  USE  OF  THE  BOND  TABLES 

1355.  To  Find  the  Net  Yield  at  an  Untdbulated  Interest  Interval. 
The  bond  tables  in  ordinary  use  are,  of  course,  based  on  an  interest 

interval  of  G  months.  It  is  sometimes  desirable  to  compare  semi- 
annual interest-bearing  bonds  with  quarterly  and  annual  interest- 
bearing  bonds  to  see  what  would  be  gained  in  net  yield  or  price, 
in  the  former  case,  or  lost,  in  the  latter. 

In  order  to  compare  such  bonds  it  must  be  remembered  that  by 
net  yield  is  meant,  as  before,  net  yield  per  annum,  figured  semi- 
annually; for  if  net  yield  meant  one  thing  in  a  semi-annual  bond, 
and  another  thing  in  a  quarterly  or  annual  bond,  there  would  be  no 
common  basis  of  comparison. 

What  would  be  the  gain  in  the  semi-annual  net  yield  if  a  20-year 
G  per  cent,  semi-annual  bond,  selling  at  125,  were  payable  quarterly  ? 

Find  the  cash  rate  of  the  quarterly  bond. 

First  quarter's  coupon  $15.00 

Interest  on  coupon  at  4$  for  91  days 15 

Second   quarter's   coupon 15.00 

Semi-annual  cash  rate  of  quarterly  bond 30.15=6.03  percent. 

coupon  rate 
Semi-annual  cash  rate  of  semi-annual  bond. .  30.00=6.00  per  cent. 

coupon  rate 

The  problem  now  resolves  itself  into  finding  the  net  yield  of  a 
20-year  6  per  cent,  semi-annual  bond  at  125,  and  a  20-year  6.03 
per  cent,  semi-annual  bond  at  125.  The  difference  in  net  yield  will 
be  the  figure  sought. 

Coupon  Rate  Net  Yield 

6.00        =  4.149  ( §  1334  et  seq.) 

6.03         =  x 

7.00        =  5.007 

x=4.175  (§1346) 
4.175— 4.149=r.026=.03 

Approximately,  then,  the  gain  would  be  .03  per  cent,  in  net  yield 
if  this  semi-annual  bond  were  payable  quarterly.  Quite  generally, 
as  in  this  case,  the  gain  in  net  rate  and  in  cash  rate  will  be  the  same. 

1356.  To  Find  the  Price  at  an  Untabulated  Interest  Interval. 
Suppose  the  two  20-year  semi-annual  6  per  cent,  bonds  just  men- 


THE  USE  OF  THE  BOND  TABLES        439 

tioned  were  not  selling  at  125,  but  on  a  4  per  cent,  semi-annual 
basis.  To  find  the  value  of  the  quarterly  bond.  The  process  again  is 
based  on  the  coupon  or  cash  rates. 

Coupon  Rate  Price 

6.00     =  127.36 

6.03     =  x 

7.00     =  127.03 

3 


X13.67=.41 


100 
127.36+.41=127.77 

1357.  To  Find  the  Price  of  Bonds  Issued  or  Maturing  at  Other 
than  the  Regular  Interest  Bates.  There  are  issues  of  bonds,  the 
prices  of  which  cannot  under  any  conditions  be  determined  by  the 
bond  value  tables.  There  has  been  reference,  for  illustration,  to  an 
issue  which  is  called  at  a  premium,  and  thus  not  conformable  to 
the  conditions  of  the  tables.  There  are  other  issues  which,  for  price, 
are  not  referable  to  the  tables  ( although  the  error  of  the  tables  might 
be  slight)  because  the  date  of  issuance,  or  maturity,  or  both,  does 
not  coincide  with  the  regular  interest  dates;  and  the  bond  tables 
presuppose  coincidence. 

1358.  There  are  two  ways  by  which  the  issuing  company  can  meet 
the  resulting  irregular  interest  obligations :  by  establishing  long  or 
short  initial  or  terminal  periods.  If  the  overlap  is  only  a  month  or 
two,  the  adjacent  periods  will  probably  be  lengthened;  otherwise 
there  will  be  short  periods.  In  either  case  the  value  of  the  interest 
coupons  will  naturally  bear  the  same  relation  to  the  semi-annual 
coupons  as  the  duration  of  the  irregular  period  bears  to  the  six- 
months'  period. 

1359.  Now  we  have  seen  that,  in  accordance  with  the  principle 
of  interest-compounding,  the  bond  value  for  each  successive  period 
is  found  by  multiplying  the  value  of  the  preceding  period  by  the 
ratio  of  increase,  and  subtracting  the  coupon  value.  Conversely, 
therefore,  the  value  of  any  period  can  be  found  by  adding  the  coupon 
to  the  next  succeeding  value,  and  dividing  by  the  ratio  of  increase. 

If,  for  instance,  then,  we  are  seeking  to  ascertain  the  value  of  a 
bond  with  an  irregular  initial  period,  but  a  regular  terminal,  we 
have  only  to  find  the  value  for  the  regular  periods  by  the  bond 
interest  tables,  add  to  this  the  long  or  short  coupon  value,  and 


440        THE  USE  OF  THE  BOND  TABLES 

divide  by  the  long  or  short  interest  ratio.    The  result  is  the  initial 
value  of  the  bond. 

1360.  Since  the  principle  is  applicable  at  any  point  in  the  life 
of  the  bond,  the  same  process  may  be  applied  to  short  or  long 
terminal  periods.  First  find  the  value  for  the  regular  periods,  add 
the  irregular  terminal  coupon  value,  and  divide  by  the  irregular 
ratio  of  increase.  This  rule  gives  us  the  basis  price  of  a  bond  having 
less  than  six  months  to  run. 

1361.  So,  also,  if  we  are  seeking  the  price  at  issuance,  of  a  bond 
with  irregular  initial  and  terminal  periods,  the  process  must  be  ap- 
plied to  both  irregular  periods. 

The  Pennsylvania  Railroad  Company  has  outstanding  an  issue  of 
Convertible  3^s,  due  Oct.  1,  1915.  Interest  is  payable  June  1,  and 
Dec.  1.  There  is  a  short  coupon  of  $11.67.  Suppose  a  bond  of  this 
issue  is  bought  Nov.  1,  1910,  to  net  4  per  cent.  To  find  the  cost 
it  will  be  necessary  to  use  the  extended  tables. 

Price  as  of  June  1,  1915,  maturity $979.2526 

Terminal  Coupon 11.67 


$990.9226 
Terminal  ratio  of  increase^  1.01333,  etc. 

/  990.9226        \ 

Price  for  the  full  life  of  the  bond  (  — —  ) $977.88 

\  1.01333,  etc.  / 

The  natural  impulse  would  be  to  figure  the  price  from  the  tables 
as  if  the  interest  dates  were  April  and  October.  This  price  is 
977.89.  The  difference  in  this  case  is,  and  it  ordinarily  would  be, 
1  cent  per  bond.  Therefore  the  correct  method  of  price  ascertain- 
ment is  necessary  only  for  schedules  of  amortization  and  accumu- 
lation. 

1362.  Bond  Issues  of  Serial  Duration.  One  of  the  characteristics  of 
industrial  corporations  is  that  they  consume  their  own  assets,  very 
generally,  in  the  production  of  wealth.  Now  that  many  of  the 
larger  industrial  companies  have  reached  a  financial  stability  that 
warrants  bonding,  many  of  their  conservative  issues  are  planned  to 
be  retired  in  serial  instalments  in  such  way  that  the  depreciation 
of  the  plant  or  commodity,  or  stock,  which  is  behind  the  bonds, 
will  be  less,  annually,  than  the  decrease  in  amount  of  bonds  out- 
standing. In  this  way  the  equity,  or  margin  of  safety,  increases 
during  the  life  of  the  loan. 


THE  USE  OF  THE  BOND  TABLES         441 

1363.  To  Find  the  Price  of  a  Serial  Issue.  If  the  loan  is  not  paid 
off  in  equal  amounts  at  equal  intervals,  there  will  probably  be  no  way 
of  computing  the  price  at  which  the  loan,  as  a  whole,  should  be 
bought  to  return  a  given  ratio  on  the  investment  for  the  length 
of  time  each  bond  is  held.  All  that  can  be  done  in  such  a  case  is 
to  price  each  maturity  on  its  basis  of  net  return  and  add  the  various 
costs. 

1364.  But,  perhaps,  more  often  than  not  there  is  uniformity  in 
the  amounts  and  intervals.  The  commonest  funded  instalment  loans 
are  the  10-year  serial  equipment,  steamship,  and  timber  issues,  which 
are  usually  retired  in  equal  annual  amounts,  beginning  one  year 
after  date  of  issuance.  The  price  of  an  issue  of  this  sort,  en  bloc, 
at  a  given  net  yield,  will  be  found  by  adding  the  prices  of  the  several 
members  of  the  series,  at  the  given  net  rate,  and  dividing  by  the 
number  of  maturities  to  get  the  average.  The  price  of  a  10-year 
serial  equipment  issue  of  5s  on  a  4  per  cent,  basis,  to  be  retired 
in  equal  annual  amounts,  is  104.76. 

1365.  It  is  still  a  common  but  wholly  wrongful  custom  to  find 
the  price  of  a  serial  issue  at  the  "  average  maturity,"  but  the  result 
is  materially  in  error,  because  the  price  of  the  several  maturities  is 
governed  not  only  by  duration  (to  which  the  arithmetical  mean 
would  apply),  but  also  by  the  semi-annual  compounding  of  the 
difference  between  the  net  and  the  cash  rates,  to  build  the  sinking 
fund,  and  there  is  no  arithmetical  mean  to  compound  interest. 

1366.  The  average  price  of  this  serial  loan  is  104.76,  and  the  price 
at  the  average  maturity  is  104.89.  Therefore  the  error  in  averaging 
the  maturity  is  .13,  which,  in  premium  bonds,  results  in  so  much 
loss  to  the  dealer  who  buys  the  entire  issue  on  "  basis "  at  the 
average  maturity,  and  sells  on  basis,  figuring  each  maturity.  Con- 
versely, in  discount  bonds  the  dealer  would  have  gained  by  the 
error. 

1367.  To  Find  the  Net  Yield  of  a  Serial  Issue.  If  this  loan  were 
brought  to  a  dealer  in  its  entirety,  and  offered  at  the  price  of  104.76, 
he  would  have  no  mathematical  means  of  finding  by  the  tables  that 
the  net  rates  of  the  several  maturities  taken  separately  were  all  4 
per  cent.  The  average  price  was  not  found  directly  from  the  tables 
but  by  averaging  the  several  prices,  and  to  find  the  net  yield  he 
must  have  the  several  prices.  But  although  the  average  price  can 
be  found  from  the  several  prices,  the  process  does  not  admit  of  re- 
versal within  the  reasonable  limits  of  simple  arithmetic  or  algebra. 

1368.  If  the  dealer  knows  or  believes  that  the  price  was  based 


THE  USE  OF  THE  BOND  TABLES 

on  a  uniform  net  yield  for  the  several  maturities,  his  rule  of  thumb 
method  of  ascertaining  it  is  to  take  the  average  maturity,  and  if  the 
average  price  is  a  premium,  to  find  what  net  yield  in  the  tables 
corresponds  in  the  5  per  cent,  column  to  the  next  lower  price.  If 
the  price  is  a  discount — to  the  next  higher  price. 

1369.  Bonds  of  Optional  Duration.  Many  issues  of  bonds  that  have 
a  definite  date  of  maturity  may  he  redeemed  by  the  issuing  company 
before  maturity.  These  are  sometimes  called  redeemable  issues,  al- 
though, unfortunately,  the  same  term  is  also  applied,  generically,  to 
all  bonds  that  do  not  represent  perpetual  loans.  For  this  reason 
the  writer  advocates  (and  has  followed  in  this  book)  the  use  of  the 
phrases  "  terminable  bonds  "  in  antithesis  to  "  perpetual  bonds,"  and 
"  redeemable  bonds  "  in  antithesis  to  bonds  not  callable  before  ma- 
turity. The  terms  of  redemption  for  bonds  of  fixed  maturity  are 
various.  They  may  be  callable  any  time  after  issuance;  or  at  a  cer- 
tain date;  or  before  a  certain  date;1  or  between  certain  dates;  or 
on  and  after  a  certain  date.  They  may  be  callable  at  par;  or  at  a 
premium.  All  these  phases  of  optional  redemption  affect  the  mathe- 
matics of  investment,  particularly  of  bond  values. 

1370.  Since  duration  is  the  variable,  the  problem  is  to  find  whether 
the  earliest  or  latest  maturity  should  be  the  basis  for  computations 
of  price  and  net  return.  The  principle  involved  is  that  the  interests 
of  borrower  and  lender  are  antagonistic,  and  since  the  option  of 
redemption  (or  repayment)  lies  with  the  borrower,  the  lender  should 
be  on  the  safe  side,  and  figure  the  value  (return)  of  his  investment 
on  the  least  favorable  possibility. 

1371.  Duration  Computed  for  Bonds  Redeemable  at  Par. 

(a)  When  the  cost  is  par  and  the  redemption  at  par,  duration  is 
negligible,  for  the  cash  and  net  return  are  always  the  same. 

(b)  When  the  cost  is  a  discount  and  the  redemption  at  par,  the 
longer  the  duration  the  less  it  will  yield,  or  be  worth;  therefore 
assume  ultimate  maturity. 

(c)  When  the  cost  is  a  premium  and  the  redemption  at  par,  the 
longer  the  duration  the  greater  the  yield;  therefore  assume  proxi- 
mate maturity. 

1372.  Duration  Computed  for  Bonds  Redeemable  at  a  Premium. 

(a)  When  the  cost  of  the  bond  is  par,  or 

(b)  When  the  cost  of  the  bond  is  a  discount,  and  the  redemption  at 

1  An  unusual  restriction ;  but  the  Chicago  City  Railway  Company  First  5s 
are  optional  at  110  and  interest  if  called  for  payment  before  February  1,  1912, 
but  not  thereafter. 


THE  USE  OF  THE  BOND  TABLES        443 

a  premium,  the  yield  will  be  least  if  held  to  maturity,  therefore 
assume  ultimate  maturity. 

(c)  When  cost  and  redemption  are  at  a  premium,  it  will  be  neces- 
sary to  find  the  net  return  to  the  ultimate  maturity;  and  then,  if 
the  price  which  corresponds  to  this  net  return  or  value,  at  the  proxi- 
mate maturity,  is  less  than  the  callable  price,  it  is  correct  to  assume 
the  bond  will  not  be  called  (since  if  it  were  called,  more  would  be 
paid,  mathematically,  than  it  is  worth),  and  consequently  to  figure 
the  bond  to  the  ultimate  maturity.  But  if  the  basis  price  is  more 
than  the  callable  price,  we  must  assume  proximate  maturity. 

In  the  two  cases  in  which  it  is  fair  to  assume  the  bonds  will  be 
called  at  the  earliest  possible  time,  it  is  customary  to  indicate  the 
possibilities  of  duration  and  net  return,  for  instance  as  follows : 

"20-40  year  6s,  to  net  4.40-6.00  per  cent." 

That  is,  the  bonds  are  40-year  6s,  redeemable  in  20  years,  and 
selling  at  a  price  to  net  4.40  per  cent.,  if  called  as  soon  as  redeem- 
able, and  it  is  right  to  expect  they  will  be.  For  any  length  of  time 
they  may  be  allowed  to  run  after  20  years  they  will  return  the  in- 
vestor the  full  cash  rate. 

1373.  Other  Bond  Tables.  Besides  the  ordinary  commercial  tables 
and  the  extended  tables,  there  are  others  of  service  to  people  who 
deal  extensively  in  bonds,  notably  those  for  serial  issues  and  for 
convertible  bonds,  and  the  tables  used  in  Canada  in  connection  with 
municipal  bond  issues,  to  figure  the  cost  and  net  return  of  bonds 
which  must  be  repaid,  periodically,  in  sums  to  cover  the  interest  and 
such  proportionate  part  of  the  principal  as  will  retire  the  issue  by 
equal  instalments  after  a  certain  number  of  years.  This  scholarly 
treatment  of  debt  reduction  is  on  the  decline  in  Canada,  and  it  has 
never  been  of  much  interest  to  United  States  investors.  Our  bond 
houses  do  not  encourage  it  because  investors  prefer  to  have  their 
principal  returned  to  them  in  round  amounts. 


CHAPTER  XXXVI 
THE  KEEPING  OF  INVESTMENT  ACCOUNTS 

1374.  The  Basis  of  Investment  Value.  It  is  the  main  premise  on 
which  rests  this  entire  treatment  of  bond  principles,  that  the  funda- 
mental difference  between  speculation  and  investment  lies  in  the 
source  of  anticipated  revenue  and  the  methods  employed  to  achieve 
that  revenue.  Profit  is  the  aim  of  speculation :  income,  that  of  in- 
vestment. One  of  the  leading  periodicals  devoted  to  the  subject 
of  speculation,  on  the  first  page  of  text  regularly  prints  the  distinc- 
tion for  its  motto : 

"  Speculation:  Operations  wherein  intelligent  foresight  is  employed  for  the 
purpose  of  deriving  a  profit  from  price  changes. 

"Investment:  The  placing  of  capital  in  a  more  or  less  permanent  way,  mainly 
for  the  income  to  be  derived  therefrom."  * 

Although  security  of  principal  is  of  first  investment  importance, 
it  is  not  the  distinguishing  characteristic  of  investment,  but  rather 
of  hoarding.  Hoarding  does  not  come  within  the  category  of  finance. 
Security  of  principal  may  be  as  strong  an  influence  in  real-estate 
speculation, — particularly  speculation  in  improved  business  prop- 
erty,— as  it  is  in  bond  investment. 

1375.  Again,  in  the  opening  paragraphs  of  the  first  of  these  chap- 
ters on  bond  mathematics,  income,  the  investment  essential,  was 
seized  upon  as  the  value-determining  factor  on  which  all  else  de- 
pended. "  Value  is  most  significantly  expressed  in  terms  of  income 
yield.  Indeed  income  yield  is  the  only  common  denominator  of 
security  values." 

1376.  By  the  statement  that  the  net  return  is  the  only  common 
denominator  of  values  is  meant  that  there  is  no  value  significance 
to  an  isolated  fact  of  price  or  cash  return,  or  duration. 

For  example,  a  $1000,  5  per  cent,  bond,  selling  at  99.07  and  in- 
terest, may  be  cheaper  than  another  selling  at  98.07  and  interest, 
because  it  may  "  run  off  "  in  two  years  and  thus  net  5|  per  cent., 
1  The  Ticker  and  Investment  Digest,  New  York. 
444 


THE  KEEPING  OF  INVESTMENT  ACCOUNTS  445 

whereas  the  other  may  run  for  10  years  and  net  only  5£  per  cent.  Or 
the  second  bond,  running  10  years,  might  be  bought  at  98.07  and  8 
years  later  be  sold  at  99.07,  yet  result  in  a  loss,  because  it  was 
bought  at  such  a  high  price  that  it  netted  only  5£  per  cent.,  and  to 
avoid  loss  should  have  been  sold  at  not  less  than  99.53,  a  5£  per 
cent,  basis.  Or  again,  a  6  per  cent,  bond,  with  4  years  to  run, 
which  is  purchased  at  105.44,  is  cheaper,  mathematically,  than  a 
3  per  cent,  bond  of  like  duration  purchased  at  95,  because  the 
premium  bond  makes  a  net  return  of  4^  per  cent,  and  the  3  per 
cent,  bond,  of  only  4|  per  cent. 

It  is,  therefore,  only  in  the  interrelation  of  all  three  facts:  the 
price,  the  periodic  cash  interest,  and  the  life  of  the  loan, — that 
valid  investment  value  is  derived  for  purposes  of  appraisal  and 
comparison.  There  is  only  one  universal  expression  of  this  value: 
in  percentage  of  net  income  to  invested  capital.  Any  f  1000  bond 
that  nets  5  per  cent.,  semi-annual,  is  always  more  valuable,  mathe- 
matically, than  any  $1000  semi-annual  bond  that  nets  4.99  per 
cent.,  irrespective  of  cost,  coupons,  or  maturity. 

1377.  Book  Value.  If  the  contention  is  correct  that  investment, 
as  distinguished  from  speculation,  seeks  revenue  from  income 
rather  than  from  profit,  and  that  investment  value  is  expressed  by, 
and  determined  by  the  rate  of  net  income,  then  a  proper  keeping 
of  investment  accounts  has,  as  its  basis,  the  net  income  return 
on  the  capital.  Since  the  investment  assumption  ordinarily  is  that 
the  bond  will  be  held  to  maturity,1  it  is  entered  on  the  books  at 
cost,  and  carried  from  interest  date  to  interest  date  on  the  basis 
of  investment  value  corresponding  to  the  cost.  Or,  to  reverse  the 
statement, — more  in  line  with  the  facts, — since  the  cost  of  the 
bond  is  determined  solely  by  the  rate  of  income  yielded  by  bonds 
of  its  particular  grade  and  characteristics,  the  cost  is  entered  as 
the  first  investment  value,  and  all  subsequent  investment  values  to 
the  last,  which  is  par,  are  entered  at  the  same  net  rate. 

True  book  value,  therefore,  may  be  defined  as  the  price  at  which 
the  bond  must  be  sold,  at  any  given  time,  to  bring  the  new  pur- 
chaser the  same  basis  of  yield  as  the  bond  brought  the  former 
purchaser  at  the  former  cost. 

Then  how  absurd  it  is  for  any  one  who  pretends  to  keep  books, 
to  carry  at  the  purchase  price  until  maturity  any  bond  not  bought 
at  par,  and  then,  as  by  magic,  to  wipe  out  the  premium  cost  or  to 
create  the  discount  gain.     Equally   fictitious  is   the  labor-saving 

1  For  exceptions,  v.  §§  1369-1372. 


440         THE  KEEPING  OF  INVESTMENT  ACCOUNTS 

device  of  charging  to  profit  and  loss  the  premium  or  discount  of  a 
lioiid,  ;ii  the  time  it  is  bought.  In  either  case,  if  the  bond  should 
be  sold,  there  would  be  no  record,  on  the  books,  of  the  gain  or  loss 
by  the  sale.  Such  a  system  of  bookkeeping  for  trust  accounts  is 
illegal  in  some  states  and  inequitable  everywhere;  for  the  integrity 
of  either  capital  or  income  will  be  impaired,  with  hardship  to  the 
beneficiaries  under  one  or  the  other.  More  illogical,  although  more 
safe,  are  regulations  such  as  those  under  which  the  savings  banks 
of  Massachusetts  keep  their  books,  by  which  discount  bonds  must 
be  carried  at  cost,  but  premium  bonds  may  be  charged  down  to 
par.  or  not,  within  the  discretion  of  the  bank. 

1378.  Market  Value.  Although  income  is  the  sole  revenue  con- 
sideration of  pure  investment,  and  net  income  return  the  sole  basis 
of  book  value,  yet,  perhaps,  as  often  as  not  there  is  the  two-fold 
purpose  to  seek  revenue  and  profit ;  or  even  if  profit  does  not  enter 
in,  at  some  future  time  it  may  be  desirable  to  convert  the  invest- 
ment into  cash.  The  latter  is  often  the  situation  when  a  mercan- 
tile concern  puts  its  surplus  into  bonds,  or  is  to  be  dissolved. 
Liquidation  value,  or  market  value,  therefore,  may  often  be  written 
to  advantage  with  book  value;  but  the  two  should  not  be  confused. 
Market  value,  in  bonds,  is  not  the  definite,  predicable  amount  that 
book  value  is.  The  market  value  of  all  issues,  except  the  very 
active,  is  very  generally  over-estimated  in  the  annual  report.  Just 
as  book  value  is  the  investment  value,  market  value  is  the  specula- 
tive value;  and  is  to  be  associated  with  the  speculative  possibilities 
indicated  in  the  quotations  of  the  following  chapters. 

1379.  When  an  investment  is  liquidated  by  sale,  the  profit  or  loss, 
which  should  be  the  difference  between  the  book  value  and  the  true 
market  value,  will,  in  the  case  of  trust  funds,  be  credited  to,  or 
debited  from  the  capital,  and  should  not  be  accounted  to  affect  the 
income;  but  the  income  thereafter  is  based  on  the  new  principal, 
and  thus  is  affected  in  its  proper  ratio. 

Schedules  of  Amortization  and  Accumulation 

1380.  Mr.  Charles  E.  Sprague  has  published  various  schedules  of 
amortization  and  accumulation,  showing  how  bond  accounts  should 
be  carried.  To  these  the  reader  is  referred  for  a  series  of  models 
more  complete  than  the  following,  which  are  based  on  Mr.  Sprague's.1 

The  constructive  principle  is  from  the  second  formula :  that  "  the 

1  The  Accountancy  of  Investment,  Chas.  E.  Sprague,  New  York,  190G,  p.  38 
et  seq 


THE  KEEPING  OF  INVESTMENT  ACCOUNTS  447 

cost  of  the  bonds  equals  the  principal  or  par  value  plus  the  premium, 
or  minus  the  discount ;"  and  that  "  the  premium  or  discount  of  a 
bond  ....  bought  above  or  below  par,  is  the  present  worth  of  an 
annuity  of  the  difference  of  rates."  * 

1381.  Schedules  for  Bonds  Bought  on  Basis.  To  cover  in  a  brief  ac- 
count the  entire  mathematical  history  of  a  loan,  suppose  a  6  per 
cent.  4-year  semi-annual  bond,  issued  Feb.  1,  1910,  and  bought  at  a 
price  to  net  4^  per  cent. 


Par 
1000.00 


Cash 

Net 

Date 

Interest 

Income 

Amortization 

Book  Value 

1910  Feb. 

1 

Q% 

m 

(cost) 

1054.40 

Aug. 

1 

30.00 

23.70 

6.30 

1048.10 

1911  Feb. 

1 

30.00 

23.60 

6.40 

1041.70 

Aug. 

1 

30.00 

23.40 

6.60 

1035.10 

1912  Feb. 

1 

30.00 

23.30 

6.70 

1028.40 

Aug. 

1 

30.00 

23.10 

6.90 

1021.50 

1913  Feb. 

1 

30.00 

23.00 

7.00 

1014.50 

Aug. 

1 

30.00 

22.80 

7.20 

1007.30 

1914  Feb. 

1 

30.00 

22.70 

7.30 

1000.00 

240.00       185.60  54.40 

1382.  The  derivation  of  the  tables  is  explained  in  §  1293  et  seq. 
An  interpretation  might  be  as  follows:  On  Aug.  1,  1912,  the 
value  of  this  investment  will  be  $1021.50.  To  realize  without  loss, 
this  sum  at  least  must  be  obtained  if  the  bond  should  then  be 
sold.  Of  the  $30.00  received  on  cashing  the  coupon,  $23.10  goes 
to  the  person  entitled  to  receive  the  income  from  the  investment; 
and  the  remaining  $6.90  must  be  laid  aside  in  the  sinking  fund 
with  the  previous  sums,  so  that  at  maturity  the  fund  will  wipe 
out  the  premium  which  was  paid  at  purchase,  but  which  will  not 
be  returned  at  maturity.  As  it  is,  the  sinking  fund  now  amounts 
to  $32.90;  and  this,  added  to  the  premium  of  $21.50  which  the 
bond  is  still  worth,  would  now  take  care  of  the  total  premium 
of  $54.40. 

1383.  The  person  entitled  at  maturity  to  the  capital  invested 
in  this  bond  is  protected  therefore  by  the  amortization  fund;  for 
at  any  interest  date  the  book  value,  which  is  the  investment  value, 
will,  with  the  accumulated  sums  laid  aside,  equal  the  original 
capital.     This  principle,   put   in   terms   of  the   schedule,   is:   The 

1  The  Accountancy  of  Investment,  p.  37. 


448         THE  KEEPING  OF  INVESTMENT  ACCOUNTS 

amortization  fund,  with  the  book  value,  is  always  a  constant,  and 
equal  to  the  capital  or  corpus  of  the  investment. 

1384.  If  more  than  one  bond  of  this  issue  were  bought,  the 
several  items  of  cash  interest,  net  income,  amortization,  and  value, 
would  simply  be  multiplied  by  the  number  of  bonds  bought.  The 
greater  the  number  of  bonds  in  the  account,  the  greater  the  cash 
error  in  using  the  two  place  tables. 

1385.  A  schedule  of  accumulation  would  treat  a  discount  bond 
account  in  exactly  the  same  way.  Suppose  a  3  per  cent.  4-year- 
semi-annual  bond,  issued  Feb.  1,  1910,  as  before,  at  a  price  to  net 
4£  per  cent.  This  is  worth  94.56,  or  exactly  as  much  less  than  par 
as   the  other  was  worth   more. 


Par 
1000.00 


Date 
1910  Feb. 

1 

Cash 

Interest 

3* 

Net 
Income 

Accumulation      Book  Value 
(cost)    945.60 

Aug. 

1 

15.00 

21.30 

6.30               951.90 

1911  Feb. 

1 

15.00 

21.40 

6.40              958.30 

Aug. 

1 

15.00 

21.60 

6.60              964.90 

1912  Feb. 

1 

15.00 

21.70 

6.70               971.60 

Aug. 

1 

15.00 

21.90 

6.90              978.50 

1913  Feb. 

1 

15.00 

22.00 

7.00              985.50 

Aug. 

1 

15.00 

22.20 

7.20              992.70 

1914    Feb. 

1 

15.00 

22.30 

7.30            1000.00 

120.00       174.40  54.40 

1386.  The  investor,  or  bank,  or  insurance  officer  may  easily 
carry  along  such  a  schedule  by  ascertaining  from  the  tables  the  ap- 
proximate book  values  each  six-months'  period.  Or  if  the  cost  at 
the  given  basis  has  been  correctly  found  to  the  cent  (from  the  ex- 
tended tables),  he  may  find  the  net  income  directly  from  the  book 
value  of  the  preceding  interest  date,  and  put  aside  in  the  sinking 
fund  the  difference  between  the  net  income  and  the  cash  interest. 
The  new  book  value  will  be  the  difference  between  the  old  book 
value  and  the  sinking  fund;  whether  less  or  more  depending  on 
whether  the  process  is  amortization  or  accumulation.  This  is 
because  the  book  value  must  decline  or  advance,  as  the  case  may 
be,  from  cost  to  par,  or  the  extent  of  the  premium  or  discount,  to 
wipe  out  the  difference  in  four  years. 


THE  KEEPING  OF  INVESTMENT  ACCOUNTS  449 

1387.  The  principal  relationships  of  figures  in  these  two  schedules 
of  amortization  and  accumulation  may  be  understood  at  a  glance 
by  a  plot  of  the  two  symmetrical  isorropic  curves  of  investment 
value.  The  reason  these  curves  are  not  straight  lines  is  because 
of  the  compounding  interest,  which  accelerates,  to  the  extent  of 
2i  per  cent,  each  interest  date,  the  fall  in  cash  value  of  bonds  bought 
above  par,  or  rise  in  bonds  bought  below. 

Chart  II 
The  Curves  of  Investment  Value 


1388.  Since  bonds  are  so  seldom  bought  on  interest  dates,  it  will 
be  necessary  to  revise  the  schedule  for  ordinary  use.  Suppose  the 
premium  bond  of  the  illustration  had  been  bought  on  May  1,  1910. 
Adjustment  of  price  by  payment  to  the  seller  of  three  months'  ac- 
crued interest  works  a  slight  injustice  to  the  buyer,  but  since  this 
injustice  is  not  corrected  in  business  practice,  the  schedule  is  not 


450  THE  KEEPING  OF  INVESTMENT  ACCOUNTS 

altered  except  in  the  returns  of  the  next  interest  period,  and  in  the 
totals. 


Date 
1910  May  1 

Cash 
Interest 
6* 

Net 
Income 

41% 

Amortization 

(cost) 

Book  Value 
1051.25 

Par 
1000.00 

Aug.  1 

15.00  net 

11.85 

3.15 

1048.10 

1911  Feb.  1 

30.00 

23.60 

6.40 

1041.70 

Aug.  1 

30.00 

23.40 

6.60 

1035.10 

1912  Feb.   1 

30.00 

23.30 

6.70 

1028.40 

Aug.  1 

30.00 

23.10 

6.90 

1021.50 

1913  Feb.   1 

30.00 

23.00 

7.00 

1014.50 

Aug.  1 

30.00 

22.80 

7.20 

1007.30 

1914  Feb.  1 

30.00 

22.70 

7.30 

1000.00 

225.00       173.75  51.25 

1389.  Although  the  cost  of  the  bond  is  $1051.25  on  May  1,  the 
bond  is  bought  "  and  interest,"  and  therefore  the  cash  outlay  May 
1,  is  $1051.25+15.00=$1066.25;  but  by  carrying  the  cash  interest 
on  July  1,  as  15.00  net,  rather  than  at  30.00,  which  is  actually  re- 
ceived, the  item  of  accrued  interest  need  not  be  entered  into  the 
account. 

1390.  The  interest  dates  of  different  bond  issues  fall  at  different 
times,  but  generally  on  the  first  day  of  the  month.  Whether  on  the 
first  or  any  other  day,  or  whatever  the  month,  it  will  be  necessary  to 
value  all  holdings  as  of  the  dates  the  account  books  are  closed. 
These  dates  are  customarily  June  30,  and  Dec.  31. 

To  achieve  this  result  in  the  4-year  bond  before  us  it  should  be 
entered  as  of  May  1,  1910,  and  the  book  values  for  June  30,  and  Dec. 
31,  1910,  by  the  rough  commercial  method  of  proportion  with  the 
known  bond  table  values  of  Aug.  1,  1910,  and  Feb.  1,  1911, — as 
follows : 


Interest  Date 

Book  Values 

Interest  Date 

New  Book  Values 
by  Proportion 

[)10  May  1 

(cost) 

1051.25 

May  1   (cost) 
June  30 

1051.25 
1049-15 

Aug.  1 

1048.10 

Dec.  31 

1042.77 

911  Feb.  1 

1041.70 

June  30 

1036.20 

Aug.  1 

1035.10 

Dec.  31 

1029.52 

THE  KEEPING  OF  INVESTMENT  ACCOUNTS  451 


New  Book  Values 

Interest  Date 

Book  Values 

Interest  Due 

by  Proportion 

1912  Feb.  1 

1028.40 

June  30 

1022.65 

Aug.  1 

1021.50 

Dec.  31 

1015.67 

1913  Feb.  1 

1014.50 

June  30 

1008.50 

Aug.  1 

1007.30 

Dec.  31 

1001.22 

1914  Feb.  1 

1000.00 

Feb.  1 

1000.00 

1391.  Having  obtained   June  30  and   Dec.  31  book  values,   the 
schedule  may  be  constructed  as  before: 


Date 

1910  May  1 
June  30 

Cash 
Interest 

10.00 

Net 
Income 

7.90 

Amortization 

(cost) 
2.10 

Book  Value 

1051.25 
1049.15 

Dec.  31 

30.00 

23.62 

6.38 

1042.77 

1911  June  30 

30.00 

23.43 

6.57 

1036.20 

Dec.  31 

30.00 

23.32 

6.68 

1029.52 

1912  June  30 

30.00 

23.13 

6.87 

1022.65 

Dec.  31 

30.00 

23.02 

6.98 

1015.67 

1913  June  30 

30.00 

22.83 

7.17 

1008.50 

Dec.  31 

30.00 

22.72 

7.28 

1001.22 

1914  Feb.  1 

5.00 

3.78 

1.22 

1000.00 

225.00 

173.75 

51.25 

Par 
1000.00 


1392.  The  schedules  have  been  based  on  the  two  place  tables  be- 
cause these  are  the  tables  in  common  use.  The  consequent  in- 
accuracy is  not  great,  but  worth  avoiding  by  the  use  of  the  extended 
tables.  As  previously  stated,  if  extended  tables  had  been  used  the 
book  values  would  have  been  correct  to  the  nearest  cent,  and  the 
semi-annual  income  could  have  been  correctly  figured  for  six  months 
at  4^  per  cent,  on  the  investment  (or  book)  value.  By  comparing 
the  multiplicand  of  2\  per  cent,  of  any  book  value  with  the  net 
income  of  the  succeeding  six-months'  interest  period,  an  idea  may  be 
had  of  the  amount  of  inaccuracy  in  this  schedule.  If  it  were  not 
for  this  inaccuracy  it  would  not  be  necessary  to  obtain  book  values 
by  proportion  after  Dec.  31,  1910,  for  the  semi-annual  instalment 


4r,L>         THE  KEEriNG  OF  INVESTMENT  ACCOUNTS 

of  amortization,  which  is  the  difference  between  the  cash  and  the 
net  interest,  is  also  the  difference  between  the  investment  value  of 
the  present  and  the  preceding  period. 

1393.  Schedules  for  Bonds  Bought  at  Price  and  Interest.  Since  the 
whole  scheme  of  investmenl  accounts  depends  on  the  rate  of  net 
income  as  its  basis,  when  bonds  are  bought  at  "  price  and  interest " 
it  is  necessary  to  convert  the  price  into  terms  of  equivalent  net 
income.  For  illustration  take  a  30-year  G  per  cent,  bond,  bought 
on  the  interest  date,  Feb.  1,  1910,  at  124. G5.  The  nearest  net  yield 
at  this  price  is  4.50  per  cent.  To  approximate  more  closely  would 
require  a  third  decimal  place  for  the  percentage  of  return;  and  this 
is  not  only  contrary  to  custom,  but  also  would  make  the  work  of 
accounting  altogether  too  laborious.  But  the  true  price  to  the  cus- 
tomary two  decimals,  at  a  4-J  per  cent,  basis  of  return,  is  124.56. 
Consequently  there  is  .09  per  cent.,  or  90  cents,  overcharge,  which 
must  be  amortized  during  the  life  of  the  loan.  If  considerations  of 
accuracy  are  less  important  than  those  of  convenience,  or  when  the 
loan  is  short  and  therefore  the  error  is  small,  this  90  cents  may  be 
cared  for  in  the  first  item  of  amortization,  thus: 

Par 
1000.00 


Date 

Cash 

Interest 
6% 

Net 
Income 

4i£ 

Amortization 

(cost) 

Book  Value 
1246.50 

1910  Feb. 

1 

j      .90 

Aug. 

1 

30.00 

27.10 

|    2.00 

1243.60 

1911  Feb. 

1 

30.00 

28.00 

2.00 

1241.60 

Aug. 

1 

30.00 

28.00 

2.00 

1239.60 

etc. 

1394.  But  if  the  number  of  bonds  of  this  issue  bought  is  large, 
or  the  loan  long,  or  greater  accuracy  desired,  the  overcharge  may  be 
distributed  as  evenly  as  may  be,  by  apportionment  among  all  the 
instalments.  In  this  issue  there  are  60  interest  dates.  A  charge 
of  2  cents  to  each  Aug.  1, — and  1  cent  to  each  Feb.  1  amortization 
will  distribute  the  90  cents  properly. 


Date 
1910  Feb. 

1 

Cash 

Interest 

6* 

Net 
Income 

4*2 

Amortization             Book  Value        Par 
(cost)  1246.50      1000.00 

Aug. 

1 

30.00 

27.98 

2.02                  1244.48 

1911  Feb. 

1 

30.00 

27.99 

2.01                  1242.47 

Aug. 

1 

30.00 

27.98 

2.02                  1240.45           etc. 

THE  KEEPING  OF  INVESTMENT  ACCOUNTS  453 

1395.  If  the  bond  had  been  bought  at  124.47,  the  nearest  net  yield 
would  still  have  been  4.50  per  cent.,  but  the  investment  would  have 
lacked  just  as  much  in  price  to  make  it  yield  4|  per  cent,  as  it 
exceeded  before.  And  so  .09  per  cent.,  or  90  cents,  must  be  accumu- 
lated by  maturity  to  meet  the  price  deficit.  This  is  done  by  with- 
holding 90  cents  from  the  first  item  of  amortization,  or  by  with- 
holding an  alternate  2  cents  and  1  cent,  as  in  the  next  preceding 
schedule. 

Cash  Net 

Date  Interest  Income         Amortization  Book  Value        Par 

1910  Feb.   1  (cost)  1244.70      1000.00 
Aug.  1      30.00        28.02              1.98  1243.72 

1911  Feb.  1       30.00        28.01  1.99  1241.73 

Aug.  1      30.00        29.02  1.98  1240.75  etc. 

1396.  Schedules  for  Bonds  Maturing  at  Other  Than  Regular  Interest 
Dates.  Bonds  which  have  a  date  of  issuance  or  maturity  different 
from  the  regular  interest  dates  cannot  be  carried  on  the  books  by 
a  schedule  derived  from  the  bond  tables.  The  price  must  first  be 
ascertained  by  the  six  place  tables,  conformably  to  the  irregular 
initial  or  terminal  period,  and  the  schedule  must  then  be  con- 
structed by  multiplication.  At  the  irregular  periods  the  investment 
value  must  be  multiplied  by  the  irregular  net  rate  to  find  the  net 
income  for  the  period,  and  this  subtracted  from  the  irregular  coupon 
interest  will  yield  the  amortization  account  for  the  period.  The 
amortization  sum,  subtracted  from  the  investment  value,  will  give 
the  succeeding  value — whether  that  value  be  the  first  regular  in- 
terest date  value  (for  irregular  initial  periods)  or  par  (for  irregu- 
lar terminals). 

1397.  Schedules  for  Serial  Bonds.  Bond  issues  maturing  serially, 
or  otherwise  partially,  are  easily  scheduled.  The  cost  of  the  series 
will  be  the  sum  of  the  costs  of  each  bond,  or  set  of  bonds,  reckoned 
according  to  maturities.  That  is,  the  total  cost  will  be  a  bill  of 
costs  on  which  there  will  be  as  many  items  as  there  are  separate 
maturities.  The  schedule  can  then  be  carried  down  by  multiplica- 
tion, as  before,  until  the  maturity  of  the  shortest  issue.  The  par 
value  plus  the  semi-annual  coupon  value  of  the  bonds  maturing  will 
then  be  subtracted  from  the  investment  value  and  the  process  of 
interest  compounding  continued. 

1398.  Schedules  for  Redeemable  Bonds.  Schedules  for  redeemable 
bonds  involve  no  principles  not  already  outlined  in  the  paragraphs 


454         THE  KEEPING  OF  INVESTMENT  ACCOUNTS 

devoted  to  Bonds  of  Optional  Duration.  Amortization  or  accumu- 
lation should  be  carried  on  from  half-year  to  half-year  on  the  basis 
of  that  duration  which  was  chosen  to  determine  the  cost  of  the 
given  bond;  for  it  will  be  remembered  that  cost  and  par  are  only 
two  of  the  series  of  investment  values,  and  duration  is  the  only 
problem  in  optional  bonds. 

1399.  In  case,  however,  that  a  bond  is  not  called,  when  according 
to  the  computation  it  is  likely  to  be,  it  should  thereafter  be  carried 
at  par,  as  aforesaid.  On  the  other  hand,  if  it  is  called  before  the 
allotted  time,  the  difference  between  the  investment  value,  at  the 
time,  and  the  redemption  value,  should  be  considered  profit,  and 
credited  to  the  capital.  Any  other  accounting  would  vitiate  the 
previously  recorded  investment  values  and  be  at  variance  with 
sound  bookkeeping. 


CHAPTER  XXXVII 
THE  FIFTY-YEAR  COURSE  OF  BOND  PRICES 

1400.  A  Bearing  of  Speculation  Upon  Investment  Security.  It  may 
occur  to  some  that,  although  a  discussion  of  prices  in  relation  to 
coupon  rates  and  par  value — such  as  that  undertaken  in  the  previous 
three  chapters — is  legitimate  and  necessary  to  a  science  of  bond  in- 
vestment, nevertheless  a  discussion  of  prices  in  relation  to  cheapness 
and  dearness  is  an  exercise  in  speculation,  and  unwarranted  in  a 
book  of  this  character. 

1401.  The  objection  is  not  without  force.  Subject  to  trifling  but 
unavoidable  inaccuracies  we  can  know  what  the  mathematical  value 
of  a  bond  is, — given  the  cost,  duration,  coupon  rate,  and  principal, — 
but  as  to  the  future  of  bond  prices,  as  to  whether  the  present  is  a 
desirable  time  to  buy  or  to  let  our  funds  remain  comparatively  idle; 
or  whether  it  is  a  favorable  time  to  liquidate  an  investment  already 
made, — we  can  only  surmise  on  the  basis  of  experience,  confident 
that  history  will  repeat  itself.    But  to  surmise  is  to  speculate. 

1402.  However,  the  so-called  exact  sciences  are  few,  and  even 
their  exactness  is  comparative.  All  that  can  be  demanded  of  a 
treatise  which  strives  to  be  scientific  is  an  adequate  provision  of 
facts,  logical  deductions,  and  a  spirit  of  fair-mindedness  in  the 
application.    All  these  are  possible  in  a  study  of  prices. 

1403.  Security  in  Liquidation.  Moreover,  the  course  and  future  of 
bond  prices  bears  a  very  intimate  relation  to  many  subjects  which 
form  the  very  corpus  of  the  science  of  bond  investment.  Most  im- 
portant of  these  subjects  are  Security  of  Principal  and  Security  of 
Interest.  It  has  been  maintained  that  security  is  not  merely  a  mat- 
ter of  the  payment  of  interest  and  principal  as  they  mature,  for  it 
may  be  found  necessary  to  liquidate  the  investment  before  maturity. 
In  such  event,  the  issues  that  fluctuate  least  in  selling  price  are  most 
secure.    This  is  what  we  mean  by  Security  in  Liquidation. 

In  a  sense,  the  security  for  New  York  City  bonds  cannot  seriously 

455 


456        THE  FIFTY-YEAR  COURSE  OF  BOND  TRICES 

be  questioned.  In  1895,  New  York  City  bonds  sold  on  a  2  per  cent, 
basis.  For  45-year  4  per  cent,  bonds  that  is  a  selling  price  in  excess 
of  150.  New  York  City  4s  may  now  be  purchased  below  par.  Was 
there  any  true  security  in  such  an  investment  16  years  ago?  Only 
providing  the  loan  is  held  till  maturity,  or  sells  on  a  2  per  cent. 
basis.  A  better  illustration: — as  long  as  this  country  maintains  a 
gold  standard,  all  American  funded  loans,  whether  gold  bonds  or 
not,  are  virtually  payable  in  gold.  If,  as  very  many  people  believe, 
the  value,  or  purchasing  power,  of  a  gold  dollar  will  continue  to  de- 
crease, indefinite^,  for  decades  to  come,  as  it  has  for  more  than  a 
decade  past,  no  thorough  study  of  tlie  security  for  bonds  can  fail  to 
consider  the  future  of  gold  prices.  But  any  course  of  conduct  based 
on  this  study  is  speculation.  Thus  is  seen  how  inseparably  related 
are  investment  and  speculation.  We  are  obliged  to  speculate  to  ob- 
tain the  greatest  possible  security  for  our  investment. 

1404.  Statistical  Difficulties  of  Price  Study.  In  discussing  bond 
prices  we  face  several  problems.  One  difficulty  is  the  limited  num- 
ber of  issues  of  which  there  are  full  and  reliable  records  of  sales 
over  a  period  of  years.  Most  loans  of  this  kind  are  active  railroad 
bonds  listed  on  the  New  York  Stock  Exchange.  To  them  might  be 
added  the  obligations  of  the  great  metropolitan  cities:  New  York, 
Boston,  Philadelphia,  Chicago,  etc.,  and  a  few  prominent  public 
service  corporation  bonds, — but  most  of  the  latter  are  listed,  even 
if  their  chief  market  is  among  the  bond  houses. 

1405.  The  market  for  the  less  well-known  bond  issues :  the  "  spe- 
cialties "  of  the  various  bond  houses,  may  be  more  or  may  be  less 
satisfactory  than  for  listed  bonds,  but  at  least  it  does  not  lend 
itself  well  to  statistical  study.  Its  quotations  are  generally  offer- 
ings, or  at  best  "  bid  and  asked  "  prices,  rather  than  actual  sale 
prices.  For  obvious  reasons  sales  of  these  specialties  do  not  find 
their  way  into  print.  If  bid  and  asked  prices  are  genuine  and  close 
enough  together, — say  within  a  point, — we  have  an  approximate 
selling  price  to  work  upon ;  but  in  general,  there  are  not  a  sufficient 
number  of  active  issues  of  the  kind  to  form  the  basis  of  statistical 
study.  For  all  practical  purposes,  then,  a  study  of  the  course  of 
bond  prices  is  a  study  of  the  prices  of  listed  bonds. 

1406.  That  price  study  is  virtually  limited  to  active  listed  bonds 
is  a  serious  restriction;  but  although  inactive  bonds,  listed  or  un- 
listed, are  not  so  sensitive  to  price  changes  and  are  more  subject, 
in  price,  to  special  influences,  nevertheless,  they  tend  to  move  in 
correspondence  with  active  listed  bonds,  and  therefore  the  causes 


THE  FIFTY-YEAR  COURSE  OF  BOND  PRICES         457 

of  the  movements  of  active  listed  bonds  are  of  interest  to  owners  of 
any  class  of  bonds.1 

1407.  Another  difficulty  in  the  study  of  bond  prices  lies  in  the 
fact  that  loans  have  a  maturity  date.  The  shorter  the  duration  of 
the  loan  is  at  any  given  date,  the  more  restricted  its  opportunity 
for  fluctuation.  Let  us  say  that  5  per  cent,  loans  of  a  certain  grade 
of  security  were  worth  4£  per  cent,  six  months  ago.  Meanwhile 
money  has  become  tighter  and  the  same  loans  are  worth  4.80  per 
cent.  At  these  rates  a  60-year  bond  will  have  declined  from  110.34 
to  103.92,  a  loss  of  nearly  6  per  cent.,  while  a  6-year  bond  will  have 
declined  from  102.60  to  101.03,  a  loss  of  only  1£  per  cent.,  approxi- 
mately; and  a  six-months'  bond  will  have  declined  from  100.24  to 
100.10,  or  about  14-100  of  1  per  cent.  It  goes  without  saying  that  the 
decline  probably  will  not  be  at  the  same  rate  for  the  three  loans; 
but  the  fact  remains  that  in  discussing  fluctuations  in  bond  prices, 
maturity  must  not  be  lost  sight  of. 

1408.  Therefore,  in  tracing  the  course  of  bond  prices,  best  results 
will  be  obtained  by  recording  only  loans  with  long  life,  for  the  price 
index  will  be  more  sensitive  to  the  current  value  of  money.  If, 
however,  the  study  is  to  extend  over  a  range  of  more  than  50  years, 
the  mere  duration  of  the  bonds  (to  say  nothing  of  other  reasons)  will 
require  the  substitution  of  new  issues  as  the  old  begin  to  lose  their 
sensitiveness  to  change  in  current  rates  because  of  the  approach  of 
maturity. 

1409.  There  is  a  duration, — and  perhaps  it  lies  around  50  years, — 
which  is  so  long  that  the  influence  of  maturity  on  the  basis  of  yield 
becomes  almost  negligible.  A  20-year  5  per  cent,  bond  on  a  4^  per 
cent,  basis  costs  106.55.  A  60-year  bond  under  the  same  conditions 
costs  110.34,  as  we  have  seen.  This  40-year  difference  in  age  is  a 
difference  of  3.97  points  in  cost.  A  100-year  5  per  cent,  bond  on  a 
4£  per  cent,  bond  basis  costs  110.98;  i.e.  a  40-years'  additional  age 
results  in  only  .64  of  a  point  additional  cost.  Therefore,  if  the 
bonds  chosen  for  study  have  50  years'  life,  or  thereabouts,  mathe- 
matical influences  have  been  properly  checked. 

1  To  relate,  in  a  very  crude  fashion,  the  course  of  municipal  bond  prices  with  the 
prices  of  listed  railroad  bonds,  it  may  be  said  that,  taking  the  average  price  of  both 
classes  in  1900  as  parity,  the  index  number  of  railroad  bonds  in  1895  was  about  86 
and  of  the  municipal  bonds  of  Boston,  Philadelphia,  and  Baltimore  was  93.  In  other 
words,  railroad  bonds  advanced  about  14  points  and  municipals  about  7.  The  prices 
of  the  municipals  were  those  the  several  cities  would  have  obtained  if  all  the  issues 
had  been  30-year  3£s. 


158        THE  FIFTY-YEAR  COURSE  OF  BOND  PRICES 

1410.  There  is  one  more  way  to  safeguard  deductions,  and  that 
is  to  (In lose  issues  which,  during  the  range  of  the  study,  fluctuate 
about  parity  as  an  average  price.  Investors  are  loath  to  buy  at  an 
extreme  discount  or  premium, — especially  at  a  premium.  Other 
Ihings  being  equal,  a  GO-year  4£  per  cent,  bond  at  par  is  more  at- 
tractive than  a  GO-year  4  per  cent,  bond  at  89.6G,  or  a  5  per  cent, 
bond  at  110.34,  although  all  three  net,  theoretically,  4£  per  cent, 
on  the  investment,  if  held  till  maturity. 

1411.  The  Subjects  of  Price  Study.  Limiting  these  observations  now 
to  active  listed  bonds  of  long  life,  that  do  not  range  at  too  great 
premium  or  discount,  the  following  phenomena  of  price  changes 
suggest  themselves  as  worthy  of  study : 

1.  Price  changes  due  to  the  development  of  national  resources, 
both  physical  ;md  financial. 

2.  Price  changes  due  to  the  course  of  the  trade  cycle,  and  in  general 
to  the  condition  of  credit. 

3.  The  future  of  bond  prices  as  indicated  by  past  and  present 
price  tendencies. 

Tub  Development  of  National  Resources 

1412.  Such  a  vast  and  comprehensive  matter  as  the  development 
of  national  resources  can  merely  be  touched  on  here;  and  it  will 
be  idle  to  carry  the  study  back  much  further  than  the  time  of  the 
Civil  War,  for  railroading,  and  railroad  prices  with  which  the 
index  of  our  national  resources  must  be  compared,  were  not  on  a 
sufficiently  stable  footing  before  the  fifties  to  make  justifiable  com- 
parison. As  for  municipal  bonds, — and  any  casual  study  of 
prices  that  might  be  made  from  them, — it  would  not  be  necessary 
to  go  back  earlier  than  the  sixties,  for  the  phenomena  that  were 
the  causes  and  results  of  the  First  Repudiation  Period  were  suffi- 
ciently like  those  of  the  Second  Period. 

1413.  Among  the  many  evidences  of  the  growth  and  develop- 
ment of  this  country  during  the  past  half  century  one  may  con- 
sider the  records  of  population,  production,  distribution,  total  busi- 
ness transactions,  and  the  estimated  national  wealth.  The  bearing 
of  these  records  upon  the  price  of  American  bonds  will  be  so  obvious 
and  general  that  the  simplest  presentation  of  the  facts  will  suffice. 
For  the  purpose  a  diagrammatical  scheme  has  been  chosen  as 
illustrating  most  clearly  and  vividly  the  changes  in  conditions 
over  a  long  period  of  time. 


THE  FIFTY-YEAR  COURSE  OF  BOND  PRICES         459 

1414.  A  distinct  advantage  of  attacking  from  chaiis  the  prob- 
lems of  price  movement  is  that  one  minimizes  thereby  the  tempta- 
tion to  make  the  facts  fit  the  theory,  rather  than  the  theory,  the 
facts;  and  equally  important,  the  charts  are  a  very  effective  check 
on  sweeping  generalizations  that  are  as  hard  to  disprove  as  to 
substantiate. 

The  development  of  national  resources  may  be  divided  roughly 
into  its  material  and  financial  aspects.     We  present,  therefore, 

1.  Charts  of  population  and  production, 

2.  Charts  of  the  volume  of  business  and  resulting  wealth, 

3.  Charts  of  resulting  security  prices. 

1415.  The  Charts  of  Population  and  Production.  Increase  in  popu- 
lation is  antecedent  and  fundamental  to  all  other  phases  of  national 
growth.  There  must  first  be  hewers  of  wood  and  tillers  of  soil,  and 
diggers  of  mines  before  crops  and  metals  are  at  our  disposal. 

From  the  strictly  investment  point  of  view,  the  truth  is  equally 
obvious.  New  lines  of  railroad,  for  which  money  must  be  borrowed, 
are  almost  invariably  projected  into  sparsely  peopled  sections. 
Their  earnings,  and  therefore  the  safety  of  their  securities  as  channels 
of  investment,  depend  on  future  settlers  and  the  traffic  these  set- 
tlers will  create  and  induce.  To  mention  but  a  few,  the  Frisco, 
the  Atchison,  and  the  Missouri  Pacific,  in  the  Southwest,  and  the 
St.  Paul  and  the  two  Hill  roads  in  the  Northwest  still  face  the 
elemental  problem  of  colonization  in  furtherance  of  future  truly 
profitable  and  secure  transportation  business.  The  New  York 
Central  proper  has  no  such  problem,  and  therefore  no  such  future. 

1416.  Growth  in  population  is  equally  the  reliance  of  industrial 
and  of  public  service  corporations.  It  is  hardly  conceivable  that 
any  business  enterprise  of  sufficient  importance  to  issue  funded 
obligations,  will  not  be  able  to  safeguard  its  creditors  more  fully 
as  the  country  increases  in  population. 

1417.  There  is  no  growth  more  steady  and  dependable  than  that 
of  population  in  the  United  States.  Although  the  figures  for  the 
country  at  large  are  taken  only  once  each  decade,  and  therefore 
the  line  of  population  could  change  direction  with  accuracy  only 
once  in  ten  years,  this  line  is  for  our  purpose  a  fair  index  of  the 
facts.  Immigration,  to  be  sure,  varies  markedly  according  to  the 
prosperity  of  the  country,  but  those  who  seek  the  unearned  incre- 
ment to  property  values,  or  to  the  margin  of  safety  in  investments, 
have  never  yet  relied  in  vain  upon  a  substantial  growth  in  popula- 


4G0 


THE  FIFTY-YEAR  COURSE  OF  BOND  PRICES 

Chart  III 

POPULATION 
O.  S.  Total  Population 


TkOTsaads 

Ycir 

2M83 

1856 

am 

1857 

1 

1858 

\ 

MM 

1859 

\ 

3144) 

I860 

\ 

33964 

1861 

I 

inm 

1862 

I 

tssta 

1S63 

I 

VIMS 

1864 

\ 

34743 

1865 

\ 

1B4M 

1866 

1 

3*311 

1867 

1 

turn 

DM 

\ 

37756 

1869 

\ 

385  5« 

1870 

I 

39555 

1871 

\ 

40596 

1872 

\ 

41677 

1873 

\ 

42796 

1874 

\ 

49151 

1875 

\ 

45137 

1876 

\ 

46353 

1877 

\ 

47598 

1878 

\ 

48866 

1879 

\ 

50155" 

1880 

\ 

51316 

1 

1881 

\ 

51495 

1882 

\ 

53693 

1883 

\ 

54911 

1884 

\ 

56148 

1885 

\ 

57404 

1886 

\ 

5S)A0 

1887 

\ 

59974 

1888 

\ 

61289 

1889 

\ 

62622 

1890 

\ 

6S844 

1891 

\ 

650.16 

1892 

\ 

66349 

1893 

\ 

6763] 

1894 

\ 

««M 

1S95 

\ 

70254 

1896 

\ 

71v'2 

1897 

\ 

72»47 

189S 

\ 

74318 

181) 

\ 

76303 

190* 

\ 

77822 

1901 

\ 

7V1SH 

1902 

\ 

80914 

1903 

\ 

82489 

19M 

\ 

84081 

1905 

\ 

85689 

1906 

\ 

87317 

1907 

\ 

88958 

1908 

\ 

'*)<,16 

1909 

\ 

922V0 

1910 

^ 

1911 

1912 

u»uuw»Mn  co  ..■.». 

THE  FIFTY-YEAR  COURSE  OF  BOND  PRICES 

Chart  IV 

COTTON 

fC  S.  Cotton  Production  (Thousands  of  pales) 


461 


1 

Year 

12874 

•1856 

3012 

1857 

\ 

3758 

1858 

V 

4310 

1859 

X 

3841 

1860 

? 

4491 

1861 

\ 

1597 

1862 

_„— —                                  *Crop  years 

449 

1863 

299 

1864 

2094 

1865 

^^"**^w                                        are  wantina.  a  commercial  cren  which  represents  the 

1948 

1866 

/                                        trade  movement  Is  taken.    The  statistics  of  produc- 

2346 

1867 

V                                      tion  have  been  compiled  from  publications  of  the 

2198 

1868 

2410 

1869 

4025 

1870 

2757 

1871 

3651 

1872 

3874 

1873 

\                      In  the  United  States,  stated  In  equivalent  500-pound 

3528 

1874 

/                      bales,  gross  weight 

4303 

1875 

^s. 

4118 

1876 

/                        (Equivalent  500-pound  bales,  gross  weight 

4494 

1877 

x 

4745 

1878 

V 

5466 

1879 

>^ 

6357 

1880 

^v. 

5136 

1881 

^^ 

6833 

1882 

— ^.^ 

5522 

1883 

^^-^ 

5477 

1884 

£ 

6369 

1885 

^s^ 

6315 

1886 

_T 

6885 

1887 

\, 

6924 

1888 

T 

7473 

1889 

Ny 

8562 

1890 

^*>^ 

894! 

1891 

JJC 

6658 

1892 

^^— — -"^ 

7433 

1893 

<^ 

10026 

1894 

7147 

1395 

^_^— — -3"" 

8516 

1896 

^-^^ 

lf'985 

1897 

*^— "— " ~»«_^ 

11435 

1898 

"\ 

9460 

1899 

^^^ 

10267 

1900 

<s 

9676 

1941 

? 

10827 

1902 

*\ 

10046 

1903 

y 

1368* 

1964 

10805 

1905 

■cr"""^^3*" 

13596 

19*6 

11375 

1907 

^^~-~~**~ 

13587 

1908 

"^^-—^^ 

10315 

1909 

r^.   — ■ — 

11426 

1910 

1911 

1912 

4G2        THE  FIFTY- YEAR  COURSE  OF  BOND  PRICES 

Chart  V 

CROPS 

1.  V.  S.  Production  of  Corn 

2.  "U.  S.  Production  of  Wheat 

3.  V.  S.  Production  of  Oats 


11          1     2   1      3 

Milliooi  olfigshtb 

Tear 

IBS* 

"857 

1858 

18S9 

lf.50 

1861 

1062 

1843 

ISM 

1845 

867 

151 

268 

1846 

2     3 

768 

212 

i78 

1867 

vl         { 

906 

224 

254 

1866 

II         \l 

874 

260 

288 

1869 

'          I 

MM 

235 

247 

1870 

r           X 

991 

230 

255 

1871 

?            ? 

1042 

249 

2V1 

1872 

li         s 

932 

281 

270 

1873 

\          / 

850 

308 

M0 

1874 

M                 / 

'321 

292 

354 

1875 

h             ^~ — 

US  J 

289 

320 

1876 

!'                             t 

1341 

364 

406 

1877 

\               \ 

1)88 

420 

413 

1878 

M                                    \ 

1547 

448 

363 

1879 

A                 V 

1717 

498 

417 

1880 

\)                         N 

1194 

383 

416 

1881 

1617 

504 

488 

1882 

*v                              ^ «^ 

1551 

421 

571 

1883 

A                     £ 

17*5 

512 

533 

1884 

\\                  *\ 

1936 

357 

629 

1885 

f  \                    > 

3665 

457 

624 

1886 

\  i                 ^ 

1456 

456 

459 

1887 

)  \              s 

1987 

415 

701 

1888 

2111 

490 

751 

1889 

N    '>                   ^ 

1489 

399 

523 

1890 

I  <r                 ^ — 

2060 

611 

738 

1891 

^i                ^^--^ 

[628 

515 

441 

1892 

/  f                  — 

1619 

3% 

438 

1893 

S  {                  ' 

121 J 

460 

662 

1894 

1               *^-——^ 

2151 

467 

824 

1895 

2283 

427 

707 

1896 

I     ?                          ^ 

1902 

530 

498 

1897 

•^    (                        — "^ 

1924 

675 

730 

1898 

\\                      I 

2078 

547 

7% 

1899 

/  \                     ^ 

2105 

522 

809 

1900 

i     ',                        \ 

1522 

2523 

748 

734 

1901 

470 

987 

1902 

'  *"**»               ~- 

2244 

437 

784 

1903 

/    s*                                  ^ 

2467 

552 

894 

1904 

2/        X                                                                \l 

7707 

692 

953 

1905 

N.         v,3                                                               \ 

2927 

735 

964 

1906 

X                                                                                    ^> 

2592 

634 

754 

1997 

'   f'                                                                                               C^ 

2669 

465 

807 

190H 

1  *                                \ 

2772 

737 

1007 

1909 

\     <w                                                                                  \ 

3126 

695 

1127 

1910 

/                                                                                                      \ 

1911 

1912 

•  HIBICAH  ■•■»  MOII  CO    ■  »,. 


THE  FIFTY-YEAR  COURSE  OF  BOND  PRICES 


463 


Chart  VI 

PETROLEUM 

U.  S.  Petroleum  Production 


Millions 
Gallons 

f 

:alendai 
Years 

^^^^^^^m                                                                                                                                                                                         MMMMM 

1856 

1857 

1858 

1859 

21 

1860 

88 

1861 

\ 

128 

1862 

109 

1863 

88 

1864 

104 

1865 

151 

1866 

1 

140 

1867 

153 

1868 

177 

1869 

220 

1870 

\ 

218 

1871 

264 

1872 

\ 

415 

1873 

\. 

458 

1874 

A 

•510 

1875 

\ 

383 

1876 

/ 

560 

1877 

\ 

646 

1878 

V 

836 

1879 

\ 

1104 

1880 

>v 

1161 

1881 

A 

1281 

1882 

\ 

984 

1883 

'S 

1017 

1884 

\ 

918 

1885 

/ 

1178 

1886 

"V 

1187 

1887 

A 

1159 

1S88 

1 

1476 

1889 

^■v 

1924 

1890 

^^^ 

2280 

1891 

^s. 

2121 

1892 

/ 

2034 

1893 

I 

2072 

1894 

2221 

1895 

\ 

2560 

1896 

^s. 

2539 

1897 

7 

2325 

1898 

/ 

2396 

1899 

\ 

2672 

1900 

N^ 

2914 

1901 

>C 

3728 

1902 

^*~^»«^^ 

4219 

1903 

^^». 

4917 

1904 

^u"> — ««^^ 

5658 

1905 

^^"■^^^ 

5312 

1906 

c 

6976 

1907 

fWYTF.— Figure  for  1875,   dlvpn  at                                                                       *"                          - 

7542 

1908 

510  millions  of  gallons,  Includes 

t7650 

1909 

all  production  prior  to  1876  In 

18847 

1910 

Ohio,  West    Virginia  and  Call- 

1911 

1912 

TAppradmate 


tmujCAn  un  noti  csjy, 


464        THE  FIFTY  YEAR  COURSE  OF  BOND  PRICES 

Chart  VII 

COAL 

U.  S.  Production  of  Coal 


MUllMt 
of  Tou 

Yctr 

U 

1854 

11 

U57 

1 

12 

1SJS 

U 

1S54 

13 

184* 

14 

1841 

15 

1842 

19 

1863 

21 

1864 

1 

21 

1865 

1 

25 

1866 

\ 

27 

1867 

\ 

29 

1868 

\ 

29 

1849 

29 

1870 

41 

1871 

\ 

45 

1872 

\ 

51 

1873 

\ 

44 

1874 

/ 

44 

1875 

47 

1876 

54 

1877 

\ 

51 

1878 

/ 

40 

1879 

s. 

43 

1880 

A 

76 

188! 

\. 

92 

1882 

>v 

103 

1883 

>v 

147 

1884 

A 

99 

1885 

/ 

101 

1886 

\ 

116 

1887 

>w 

132 

1888 

>w 

126 

1889 

/ 

140 

1890 

>v 

150 

1891 

\ 

160 

1892 

\ 

162 

1893 

1 

152 

1894 

/ 

172 

1895 

>v 

171 

1896 

1 

178 

am 

\ 

196 

1898 

>y 

226 

1899 

^*^^^ 

240 

1900 

>^ 

261 

1901 

\. 

269 

1902 

\ 

319 

1'I03 

^"— «^^ 

314 

1W4 

_JT 

350 

1905 

^^^ 

349 

1906 

>^ 

429 

1907 

-~^^^ 

371 

1908 

^^— -■■"*' 

410 

1909 

■^^^ 

445 

1910 

._ 

1911 

1912 

HWyi  MU  aolc  lu   •  r 


THE  FIFTY-YEAR  COURSE  OF  BOND  PRICES 


405 


Chart  VIII 


IRON  AND  STEEL 

1.  U.  S.  Production  of  Pig  Iron 

2.  U.  S.  Production  of  Steel 


1  1    1  2 

Tootuacdi  of  Tons 

C 

Yean 

788 

1856 

712 

1857 

| 

629 

1S58 

I 

750 

1859 

|1 

821 

1S60 

1 

653 

1861 

/ 

703 

1862 

1 

846 

1863 

\ 

1014 

1864 

\ 

831 

1865 

/ 

1205 

ie.,6 

\ 

1305 

19 

1867 

\ 

1431 

26 

1868 

1   \ 

1711 

31 

1869 

i  \ 

1665 

68 

1870 

i  I 

1706 

73 

1S71 

j  1 

2548 

142 

1872 

j   V 

2560 

198 

1873 

j   j 

2401 

215 

1874 

j   / 

2023 

389 

1875 

■.   / 

1868 

533 

1876 

\  I 

2066 

569 

1877 

1  \ 

2301 

731 

1878 

\  \ 

2741 

935 

1879 

\  V 

3835 

1247 

13- 9 

4114 

1588 

1881 

\     Y 

4623 

1736 

1882 

\ 

4595 

1673 

1883 

1 

4097 

1550 

1884 

r     / 

4C44 

1711 

1885 

'     f 

5683 

2562 

UM 

^    \ 

6417 

3339 

1887 

\     \ 

6489 

2899 

1888 

>     \ 

7603 

3385 

1881 

\         \ 

9202 

4277 

1890 

8279 

3984 

1891 

>       f 

9157 

4927 

1892 

s       \ 

7124 

4019 

1893 

/      ^ 

6657 

4412 

1894 

V      L 

MM 

6114 

1895 

*>^      * — , 

8623 

5281 

1896 

•         / 

9652 

7156 

1897 

\      \ 

11773 

8932 

1898 

■^.     ^^ 

13620 

10639 

1899 

'^      ^N. 

13789 

10188 

1900 

/            \ 

15878 

13473 

1901 

17821 

14947 

1902 

^v.    S^ 

18009 

14534 

1903 

>   ^ 

!M97 

13859 

1904 

(      s 

23992 

24023 

1905 

25307 

23398 

1906 

""*■*••— «.7*«««w 

25781 

23363 

1907 

^*V 

15936 

14023 

1908 

25795 

33955 

1909 

27304 

26095 

1910 

2   ""^.^V 

1911 

! 

1 

1912 

1 

AUEBICAN  SANK  ■OTECO..N.V 


400        THE  FIFTY-YEAR  COTRSE  OF  BOND  PRICES 

Chart   IX 

COPPER 

U.  S.  Production 


Tboiund 
of  Tom 

t             ( 

alendar 
Yurs 

4 

1856 

4 

1S57 

S 

L  1S-.S 

4 

IKS') 

7 

1»6I) 

7 

1KM 

9 

IS62 

8 

1863 

8 

1864 

8 

1865 

8 

1866 

14 

1867 

11 

1868 

1] 

1869 

1] 

1870 

13 

1H71 

12 

1872 

IS 

1873 

17 

1874 

18 

187S 

19 

1876 

21 

1877 

21 

1878 

23 

1879 

I 

27 

1880 

\ 

32 

1881 

\ 

40 

1882 

\ 

51 

1883 

V 

64 

1884 

\ 

74 

f885 

\ 

70 

1886 

/ 

81 

1887 

\ 

101 

1888 

\y 

101 

1889 

1 

115 

1890 

V 

124 

1891 

\ 

154 

1(93 

^w 

147 

1893 

7 

158 

1K94 

\ 

169 

1895 

\\ 

205 

1896 

^>^ 

220 

1897 

^v 

235 

1898 

\^ 

.il 

1899 

>. 

270 

1900 

>^ 

268 

1901 

1 

294 

1902 

^v 

311 

1903 

N. 

362 

1904 

^^>^ 

402 

1905 

^"^^^ 

409 

1906 

\ 

388 

1907 

/ 

421 

i<m« 

^ 

491 

1909 

481 

1910 

y 

1911 

1912 

ASUl&MI  Ull  HOII  CO    ■  t. 


THE  FIFTY-YEAR  COURSE  OF  BOND  PRICES         467 

tion  from  decade  to  decade,  or  from  one  revolution  of  the  trade 
cycle  to  the  next. 

1418.  The  lines  for  crops  and  minerals  on  these  charts  picture 
the  growth  in  production  of  the  more  important  commodities, — 
all  thoroughly  representative  of  their  kind.  Since  cotton  must  be 
expressed  in  bales,  and  corn,  wheat  and  oats  in  bushels,  it  is  not 
possible  to  put  the  graphs  of  all  four  crops  in  one  chart.  For  a 
similar  reason,  petroleum  must  be  separate  from  coal  and  the 
metals.  Although  the  outputs  of  coal,  of  iron,  of  steel,  and  of 
copper,  are  all  expressed  in  weight,  the  quantities  mined  of  each 
are  so  different,  that  only  steel  and  iron  can  express  on  the  same 
diagram  their  relative  outputs.  It  will  be  observed  that  quantita- 
tive variation  is  expressed  in  these  charts  by  distance  from  left  to 
right,  rather  than,  as  often,  from  a  base  line  upward  and  down- 
ward. 

1419.  Increased  production  means  increased  traffic  and  trans- 
portation facilities,  increased  demand  for  machinery,  power,  labor, 
skill,  wages,  and  money  and  other  instruments  of  credit.  Increased 
production  means  the  necessity  of  standardization  in  grades  and 
quantities  of  manufacture,  in  hours  and  terms  of  employment,  in 
all  contracts  for  future  delivery,  in  the  creation  and  security  of 
funded  loans  with  which  to  finance  industry. 

Other  things  being  equal,  a  gain  in  the  elements  of  security 
enhances  the  value  or  price  of  bonds,  and  therefore  the  rapid  in- 
crease of  population  and  annual  production,  indicated  by  the  charts, 
creates  a  tendency  toward  higher  bond  prices. 

1420.  The  Charts  of  Business  and  Per  Capita  Wealth.  Out  of  the 
fulness  of  statistical  material  it  is  difficult  to  choose  the  three 
or  four  most  significant  manifestations  of  the  country's  growth 
in  the  volume  of  wealth  distributed  (physically  speaking)  to  re- 
late to  the  growth  of  individual  wealth,  and  therefore  to  apprecia- 
tion in  security  values. 

1421.  The  absolute  and  the  relative  volumes  of  the  movements 
of  goods  to  and  from  the  United  States,  express  satisfactorily  the 
foreign  trade.  For  our  purpose  these  volumes  are  most  expressive 
in  terms  of  value.  It  is  seen  that  the  growth  of  foreign  trade  has 
kept  pace  with  the  growth  in  production.  Equally  important,  since 
1875  the  balance  of  trade  has  been  continuously  in  our  favor  (with 
two  trivial  exceptions),  although  prior  to  1875,  it  was  equally  true 
that  imports  exceeded  exports. 


468        THE  FIFTY-YEAR  COURSE  OF  BOND  PRICES 

Chart  X 

IMPORTS  AND  EXPORTS 

1.  V.  S.  Merchandise  Exports 

2.  U.  S.  Merchandise  Imports 


1     1    2 

Millions  of 
Mian 

VMM  MM 

r  mi 

310 

'.  56 

293 

348 

1817 

\ 

272 

263 

11)53 

K 

»J 

331 

1859 

V2 

333 

353 

1S«1 

V 

219 

289 

1861 

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THE  FIFTY-YEAR  COURSE  OF  BOND  PRICES        469 

Chart  XI 

BANKS 

1.  N.  Y.  Clearings 

2.  V.  S.  Clearings 


1    1         1     2 

1 

MIDon  of  Dolhn 

Vears Ended 
September  IS                                                                                                 ._ 

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8133 

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UOUM  HSMII  »-.»#•• 

471)        THE  FIFTY  YEAR  COURSE  OF  BOND  PRICES 

The  resulting  annual  credit  balance,  which  has  averaged  nearly 
$500,000,000  for  the  past  10  years,  serves  to  offset,— at  least  in 
part,— the  so-called  ''extra-trade"  debit  incurred  by  Americans 
sojourning  abroad,  and  incurred  by  importation  and  exportation 
in  foreign  vessels,  and  by  the  tribute  to  foreign  capital  of  insurance 
premiums  and  security  dividends  and  interest.  In  postponing  to 
an  indefinite  future  a  debit  balance  from  the  shipment  of  gold  to 
and  fro,  the  trade  balance  in  our  favor  has  helped  to  make  possible 
the  increase  in  per  capita  circulation  within  the  United  States. 

1422.  In  1856  this  circulation  was  f  15.16.  During  the  years  of 
debit  trade  balances  this  circulation  never  rose  higher  than  $20.57 
and  then  only  in  the  inflation  of  the  war  times.  But  from  a  low 
mark  of  $15.32  in  1878  it  has  advanced  with  only  a  single  note- 
worthy recession  (during  the  mid-nineties)  to  $35.01  in  1909,  and 
by  thus  helping  to  lessen  what  would  otherwise  have  been  the  demand 
for  money,  it  has  tended  to  increase  bond  prices. 

1423.  The  line  of  bank  clearings  is  more  comprehensive  in  its 
reference  to  industrial  growth  than  the  line  of  foreign  trade.  It 
represents  the  total  exchanges  of  bank  credit  through  the  clearing 
houses  of  the  entire  country,  and  graphically  portrays  the  volume 
of  business;  for  in  the  opinion  of  the  Comptroller  of  the  Currency, 
nearly  90  per  cent,  of  all  business  in  the  United  States  is  now 
transacted  by  checks.  The  relation  of  the  volume  of  clearings  to 
bond  prices  is  not  direct  but  collateral,  and  the  volume  affects  the 
trade  cycle  movement  of  bonds  as  much  as  it  does  the  trend  of 
prices  over  the  decades;  but  because  of  the  comprehensiveness  of 
bank  clearings  as  an  expression  of  the  country's  business  develop- 
ment, it  is  well  to  include  the  graph.  Unfortunately  figures  are 
available  only  for  years  since  1881.  Therefore  clearings  at  New 
York  have  been  added  to  give  a  better  idea  of  the  50-year  trend. 

1424.  The  line  of  increase  in  wealth  for  each  inhabitant,  like 
the  line  of  population,  is  made  possible  by  the  Federal  census,  and 
until  the  beginning  of  this  century  could  be  corrected  only  once 
each  decade;  but  the  special  census  report  of  1904  gives  new  direc- 
tion from  1900. 

The  growth  of  both  crop  and  mineral  production,  with  the  result- 
ing increased  business,  evidenced  by  foreign  trade  and  bank  clear- 
ings, is  sufficient  testimony  to  the  growth  of  the  United  States 
in  wealth.  Since  the  population  has  increased  substantially  also, 
it  may  not  be  so  clear  that  individual  wealth  has  achieved  a  pur- 
chasing power  of  sufficient  importance  to  create  a  per  capita  invest- 


THE  FIFTY-YEAR  COURSE  OF  BOND  PRICES        471 


Chart  XII 


WEALTH 

V.  S.  Wealth  per  Capita 


Dollars 

Year 

1856 

1857 

\ 

1858 

\ 

1359 

\ 

$13 

1860 

\ 

1861 

y 

1862 

\ 

1863 

\ 

1864 

\ 

1865 

\ 

1866 

V 

1867 

\ 

1868 

\ 

1869 

\ 

779 

1870 

\ 

1871 

i 

1872 

i 

1873 

I 

1874 

I 

1875 

l 

1876 

I 

1877 

I 

1878 

I 

1879 

I 

850 

1880 

I 

1381 

\ 

1882 

\ 

1883 

\ 

1884 

\ 

1885 

\ 

1836 

v 

1887 

\ 

1888 

Y 

1889 

\ 

1038 

1890 

Y 

1891 

\ 

1892 

\ 

1893 

\ 

1894 

\ 

1895 

\ 

1896 

V 

1897 

\ 

1898 

\ 

1899 

\ 

1164 

1900 

\ 

1901 

V 

1902 

V 

1903 

\ 

1310 

1904 

\ 

1905 

\ 

1906 

* 

1907 

\ 

1908 

1909 

> 

1910 

\ 

1911 

1912 

APiniCAN  IANK  HOTI  C9UM-V 


472        THE  FIFTY-YEAR  COURSE  OF  BOND  PRICES 

ment  demand  which  would  affect  bond  prices.     The  graph  of  per 
capita  wealth,  however,  speaks  for  itself. 

1425.  We  may  rightly,  then,  picture  the  great  rise  in  bond  and 
stock  prices  as  assisted  from  below,  so  to  speak,  by  support  of  in- 
trinsic merit  and  from  above  by  the  increasing  demand  of  surplus 
wealth. 

1426.  One  must  not  forget  the  decreased  value  of  a  dollar;  am. 
a  correction  due  to  the  fact  is  necessary  for  the  past  13  years  in 
studying  all  charts  having  to  do  with  prices  and  money.  Still  it  is 
this  unprecedented  per  capita  wealth  which  vests  the  ownership  of 
the  United  States  Steel  Corporation  in  95,000  men  and  women,1  and 
that  of  the  Pennsylvania  Railroad  in  60,000,  and  makes  reasonable 
the  estimate  that  5,000,000  people  in  the  United  States  are  proprie- 
tors of  corporate  undertakings.  The  generality  of  financial  power 
and  intelligence  which  these  figures  imply  has  had  much  to  do  with 
the  50-year  uplift  in  bond  prices. 

1427.  The  increase  in  per  capita  wealth  signifies  an  investment 
buying  power  of  which  few,  except  those  in  the  bond  business,  or 
in  the  security  selling  business  in  general,  have  any  adequate  idea. 
Europe, — particularly  France, — is  still  absorbing  annually  an  im- 
mense volume  of  our  bonds,  but  not  immense  as  compared  with 
America.  No  Barings  of  London,  nor  Hopes  of  Amsterdam,  are 
now  paternally  protective  to  the  market  prices  of  our  civil  and 
railroad  loans.  Even  our  own  banking  and  insurance  institutions 
are  gradually  giving  way  in  importance,  as  they  long  since  did  in 
France,  to  the  much-talked-of  private  investor.  The  increase  of 
per  capita  wealth  and  the  beginnings  of  a  general  spirit  of  invest- 
ment have  caused  the  rise  of  the  American  bond  house. 

1428.  There  are  any  number  of  statistical  graphs  which  might 
be  added  to  these  to  show  the  physical  and  financial  development  of 
the  country  during  the  past  half  century: — such  as  the  Stock  of 
Gold  Money  in  the  United  States,  and  Railroad  Gross  Earnings, 
which  is  an  index  of  the  volume  of  goods  going  to  market,  etc.,  etc., 
but  the  lines  we  have  are  sufficient  to  make  obvious  the  connection 
with  bond  and  stock  prices. 

1429.  The  Charts  of  Security  Prices.  The  charts  of  security  prices 
must  be  used  with  caution.  Owing  to  the  wider  fluctuations  of 
shares  the  stock  chart  is  drawn  to  a  different  horizontal  scale. 
One's  first  impression  is  that  the  net  advance  of  bonds  from  1856 

1  According  to  the  books  of  the  Company.  This  does  not  include  certain  foreign 
holdings  deposited  with  syndicates. 


THE  FIFTY-YEAR  COURSE  OF  BOND  PRICES        473 

Chart  XIII 


BOND  PRICES 

1.  Trend  of  10  Characteristic  Railroad  Bonds 

2.  Trend  of  4  Characteristic  Railroad  Bonds 

3.  Trend  of  4  Bonds  in  Terms  of  Gold 


i#3.«5 


104.44 


1*6.4* 


1*4.58 


1*1.09 


102.65 


IM.71 


IM.47 


111.02 


103.61 


94.44  >103.«S 


1*8.61 


<1*3.W 


ISO! 


IMS 


19*6 


19*7 


i-il 


,-,■  | 


;v.. 


1911 

19:: 


t  Actual  average  percentage  prices 
are  given  in  column  2.  Each 
division  line  In  this  column  in- 
dicates a  chanse  In  the  bond  list 

{Percentages  corrected  for  the 
changesia  the  list  are  given  In 
column  3,  proportioned  to  show 
the  true  market  trend 


ABfBICjm  MIK  HOT!  CO-JI.T. 


474        THE  FIFTY  YEAR  COURSE  OF  BOND  PRICES 

Chart  XIV 

STOCK  PRICES 

1.  Trend  of  10  Characteristic  Railroad  Stocks 

2.  Trend  of  4  Characteristic  Railroad  Stock* 

3.  Trend  of  4  Stocks  In  Terms  of  Gold 


1     |    2    |    3 

I           I 

Dollar*  per  Sbt/s 

Calendir 

\\ttn  \k> 

60         60          70          80          OO         IOO         110         120         130        140       IfiO        ISO         170         180        10O        2CO 

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Resumption  of  Specie  Payments,  January  1 

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1881 

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1882 

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1883 

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1884 

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1885 

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1894 

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1897 

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1898 

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1900 

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104.3 

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96.. 30 

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99.2 

1904 

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1906 

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103.43  "104.0 

1907 

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THE  FIFTY-YEAR  COURSE  OF  BOND  PRICES        475 

to  the  present  has  been  greater  than  that  of  stocks.  As  a  matter 
of  fact  the  reverse  is  the  case.  Bonds  have  advanced  from  75.22 
(with  price  corrected  on  the  basis  of  the  most  recently  used  four 
bond  issues)  to  103.05  in  1907,  and  stocks  from  74.2  to  104.0  in  1907 
where  the  four-security  table  ends. 

The  lines  of  10  securities,  in  both  charts,  beginning  in  1898, 
succeed  the  lines  of  four  securities,  in  order  to  make  the  graphs 
more  comprehensive.  The  10  issues  that  form  the  solid  line  of 
bond  prices  are  named  in  §  1470. 

1430.  It  is  to  be  regretted  that  space  does  not  permit  a  careful 
study  of  these  two  50-year  charts  in  relation  to  each  other.  We 
shall  have  something  to  say  of  them  in  the  succeeding  chapter. 
Here  it  is  enough  to  invite  comparison  of  the  chart  of  bond  prices 
during  the  past  50  years  with  the  charts  that  have  preceded.  It 
would  be  merely  confusing  to  point  out  similarities  and  differences. 
Some  may  choose  to  work  out  their  deductions  from  the  figures 
in  the  columns,  reducing  progress  to  percentage;  for  most  it  will 
be  sufficient  to  visualize  the  course  of  slow  growth  through  many 
years,  from  small  beginnings,  and  then  the  almost  abrupt  advance 
toward  present  prosperity  which  began  about  1896.  It  will  be 
evident  to  all  that  conditions  of  population,  production,  exchange, 
and  the  like  have  been  the  influences  that  have  given  direction  to 
the  50-year  trend  of  stock  and  bond  prices.  Let  us,  then,  in  the  next 
study,  turn  the  magnifying  glass  on  the  course  of  security  prices, 
to  see  what  may  cause  the  minor  movements  of  bond  prices,  and 
how  important  these  movements  are. 


CHAPTER  XXXVIII 
BOND  PRICES  IN  RELATION  TO  THE  TRADE  CYCLES 

1431.  The  great  advance  in  bond  prices  over  a  period  of  half  a 
century  or  more  has  been  a  matter  of  historic  interest,  and  certain 
fundamental,  but  rather  obvious  truths  have  been  developed  from 
it.  This  advance  cannot  continue  indefinitely,  if  for  no  other  reason 
than  because  of  the  low  return  which  bonds  yielded  at  the  high 
prices  of  1902  and  1905.  As  the  price  is  indefinitely  raised  the  net 
yield  approaches  zero  for  its  limit,  just  as  in  geometry  the  hyperbola 
approaches  the  asymptote.  In  1902  the  net  return  on  the  average 
prices  of  the  ten  bonds  in  Chart  XIII,  line  1,  was  3.87  per  cent. 

1432.  But,  though  we  cannot  count  very  much  if  any  longer  on 
a  general  trend  toward  higher  prices,  still  we  may  increase  the 
safety  of  an  investment,  and  at  the  same  time  assure  ourselves  of  a 
reasonable  likelihood  of  speculative  profit,  by  buying  bonds  during 
the  recurring  price  recessions  due  to  the  revolutions  of  the  trade 
cycle. 

The  first,  or  50-year  upward  movement  of  bonds,  already  culmi- 
nated, has  been  seen  to  rest  upon  the  general  physical  and  financial 
condition  of  the  country.  It  remains  to  note  the  causes  of  the 
equally  marked  secondary  movement. 

1433.  The  15-Year  Charts.  Before  taking  them  up,  however,  a 
word  is  necessary  concerning  the  nature  of  the  charts  of  this  chap- 
ter, which  are  different  from  those  used  heretofore.  The  15-year 
charts  are  adapted  from  the  charts  of  the  Financial  Graphic  Co. 
of  New  York,  whose  interest  and  scholarly  assistance  have  been  in- 
valuable. Each  horizontal  line  represents  a  quarter  year,  instead  of 
a  year,  and  the  column  figures  divide  the  quarters  into  months. 

"In  following  the  general  trend  of  financial  business  movements,  experience  has 
taught  that  averages  over  too  short  a  period  or  too  long  a  period  are  equally  mislead- 
ing. On  the  former  basis  the  ceaseless  waves,  though  only  on  the  surface,  may  en- 
tirely disguise  the  steady  influx  or  efflux  of  the  financial  tide,  while  on  the  latter 
basis  more  or  less  of  the  tidal  movement  itself  may  be  averaged  away  against  its  own 
counter-movement.    From  month  to  month  has  been  found  the  most  practical  period 

476 


BOND  PRICES  IN  RELATION  TO  THE  TRADE  CYCLES     477 

for  the  comparison  of  trends  which  may  take  several  months  to  show  definite  tend- 
ency or  change,  and  many  months  or  even  years  to  run  their  full  course.  On  this 
basis  the  smaller  superficial  movements  are  averaged  away,  leaving  the  general 
movements  clearly  defined."  * 

1434.  The  graphs  of  the  charts  in  this  chapter,  and  the  figures 
that  project  them,  do  not  indicate  the  variation  from  some  arbi- 
trary base  of  thousands  of  tons,  or  millions  of  bushels,  as  in  the 
previous  and  in  the  succeeding  chapter,  but  in  each  case  they  show 
the  degree  of  variation  from  a  10-year  average  taken  as  parity. 
"  Although  temporary  phases  of  related  subjects  may  be  at  variance, 
over  a  10-year  period,  their  fundamental  relations  must  obtain." 

Therefore,  the  monthly  numbers  representing  security  prices  in 
the  columns  at  the  sides  are  not  the  average  prices  of  10  railroad 
bonds  or  stocks  for  the  given  month,  but  they  are  the  "  Relative 
Index  Numbers,"  showing  the  percentage  relation  of  those  monthly 
average  prices  to  the  10-year  average  which  is  the  base  line,  or 
parity.  It  is  difficult  to  compare  the  variations  of  tons  with  those 
of  bushels;  but  percentages  are  always  comparable. 

1435.  A  comparison  of  the  courses  of  stock  prices  and  bond 
prices  over  the  past  15  years  (Chart  XV)  shows  us  several  things 
of  interest  in  connection  with  these  movements. 

1.  The  movements  are  nearly  coextensive  in  time. 

2.  But  when  not  coextensive,  the  movement  in  bonds  anticipates 
the  movement  in  stocks. 

3.  In  both  cases  price-depression  is  usually  brief  and  acute,  but 
price  elevation  is  prolonged,  and,  especially  in  the  case  of  bonds, 
the  change  to  the  downward  trend  is  very  gradual. 

4.  The  range  of  stock  fluctuation  is  several  times  that  of  bonds. 

5.  Over  the  past  10  years  the  trend  of  stocks  has  been  slightly 
upward,  but  of  bonds,  slightly  downward. 

1436.  Approximate  Synchronism  of  the  Stock  and  Bond  Price  Move- 
ments. The  fact  that,  in  a  general  way,  bonds  advance  or  decline 
with  stocks  suggests  the  feasibility  of  "  playing  the  panics,"  if  one 
is  so  circumstanced  that  this  is  possible.  Most  institutions,  of 
course,  and  trustees,  and  persons  unfamiliar  with  business  condi- 
tions, cannot  avail  themselves  of  the  speculative  opportunities  and 
responsibilities  which  recurring  panics  present.  But  others, — the 
small  minority, — who  are  not  restricted  by  law,  or  their  own  limita- 
tions, need  have  no  difficulty  in  deciding  when  to  buy.  A  panic 
needs  no  label  on  its  arrival.    Synchronism  in  the  movements  of  se- 

1  The  Financial  Graphic  Company. 


478     BOND  PRICES  IN  RELATION  TO  THE  TRADE  CYCLES 


Chart  XV 


Rnllroid  Stock  Prices— Relative  Index  Numbers  (Average  1898-1907- 
Railroad  Bond  Prices— Relative  Index  Numbers  (Average  1898-1907= 


100  Per  Cent.) 
100  Per  Cent.) 


0%  60%  100% 

♦Period*  Included  In  week*  ended  Friday  during  oach  Calendar  month. 

A  Composite  of  Charts  that  are  copyright,  1910,  by  the  Financial 


140% 

Graphic 


tow:;, 


Co. 


BOND  PRICES  IN  RELATION  TO  THE  TRADE  CYCLES     479 

curity  prices  helps  us  to  obtain  that  investment  quality  we  have 
spoken  of  as  "  security  in  liquidation." 

1437.  That  bond  and  stock  price  movements  are  almost  syn- 
chronous suggests  that  the  same  conditions  are  operative  upon  them 
both,  and  that  these  conditions  are  general  in  character.  Therefore, 
we  may  conclude  that  in  considering  the  future  of  bond  prices  in 
their  secondary  movements,  we  shall  have  to  deal  with  much  the  same 
phenomena  as  we  do  in  dealing  with  the  round  of  business  condi- 
tions. The  man  who  has  sufficient  wisdom  and  foresight  to  know 
when  to  overstock  his  granaries  or  warehouses  for  the  demand 
which  is  to  come,  and  when  to  curtail  his  credits  and  reduce  his 
stock  and  output,  is  competent,  after  some  study  of  the  differentials, 
to  gage  the  proper  time  at  which  to  buy  and  sell  his  active  bonds. 

1438.  It  will  be  noted  that  prior  to  the  new  century  prices  had 
not  swung  into  that  almost  rhythmic  movement  which,  graphically 
indicated  by  the  three  "  scallops  "  since  1900,  is  a  manifestation  of 
the  recurring  trade  cycles.  In  the  irregular  advance  of  both  stock 
and  bond  prices  in  the  late  '90s  we  find  little  that  is  pertinent  to 
the  present  discussion.  The  West  had  not  become  sufficiently 
settled  and  developed  for  periodic  recurrence  of  credit  evolutions. 

But  in  the  second  quarter  of  1902  there  set  in  a  decline  in  bonds 
which  continued  without  reaction  until  the  "  rich  man's  panic  "  of 
1903.  Stock  prices,  however,  kept  on  advancing  until  into  the  third 
quarter  of  1902.  The  recovery  of  bond  prices  from  this  panic  was 
immediate,  but  stock  prices  held  at  bottom  for  about  eight  months. 

1439.  The  advance  in  bonds  from  the  panic  of  1903  culminated 
in  the  third  quarter  of  1905,  but  the  first  serious  slump  in  stocks 
did  not  occur  until  about  the  beginning  of  1906.  There  was  a  sharp 
recovery  in  stocks  during  the  summer  of  1906,  but  bonds  continued 
their  downward  course  until  the  November  panic  of  1907,  and  in 
so  doing,  served  notice  that  liquidation  in  stocks  was  probably 
imminent.  As  in  1903,  immediately  after  the  panic,  bonds  recovered 
the  worst  of  their  loss  much  more  quickly  than  did  stocks. 

Bond  prices,  then,  anticipate  stock  prices  in  substantial  recovery 
after  a  crisis,  and  in  reversal  of  trend  during  prosperity. 

1440.  The  history  of  1905  and  1906  is  being  repeated  now.1  There 
has  been  no  advance  in  listed  bond  prices  since  the  latter  part  of 
1908,  and  in  the  summer  of  1909  the  trend  turned  decidedly  down- 
ward.   Stocks  followed  the  bond  trend  a  little  later. 

»The  autumn  of  1910. 


480     BOND  PRICES  IN  RELATION  TO  THE  TRADE  CYCLES 

1441.  It  is  commonly  held  that  the  stock  market  is  the  primary 
index  of  forthcoming  business  conditions,  but  still  more  truly  is 
the  listed  bond  market  anticipatory.  Not  only  do  bond  movements 
tend  1o  anticipate  stock  movements  from  season  to  season,  but  the 
priority  is  somewhat  noticeable  in  the  larger  movements  of  stocks 
and  bonds,  the  trend  of  which  is  ascertained  by  averaging  stock  and 
bond  prices  year  by  year.  One  can  observe  this  by  comparing  the 
respective  lines  on  the  chart  of  50-year  security  prices. 

1442.  The  Business  Cycle.  The  explanation  of  the  priority  is 
bound  up  in  the  whole  principle  of  the  secondary  price  movement, 
or  the  business  cycle,  which  is  presented  here  as  briefly  as  possible. 

There  is  no  reason,  apart  from  the  poor  judgment  and  lack  of 
foresight  of  mankind  why  we  should  suffer  from  the  perennial  ex- 
tremes of  prosperity  and  adversity.  The  root  of  it  all  is  not  in- 
herent in  the  physical  or  business  world.  Crops  may  fail  us  and 
become  a  tributary  cause,  unsound  currency  or  banking  legislation 
may  accelerate  a  collapse  of  credit,  but  neither  crops  nor  currency 
of  themselves,  alone,  have  produced  a  drastic,  country-wide  liquida- 
tion. This  can  happen  only  when  it  is  necessary  to  liquidate  capital 
as  a  whole. 

1443.  The  ultimate  cause  of  the  trade  cycle  is  over-speculation. 
Speculation  is  not,  of  course,  a  special  business.  It  is  almost  as 
native  to  the  race  as  breathing.  When  strawberries  are  three  boxes 
the  quarter,  and  a  cool  spring  has  reduced  the  price  of  suits,  the 
consumer  buys  more  than  enough  for  present  requirements;  he 
anticipates  the  needs  of  to-morrow  and  next  summer. 

1444.  The  business  cycle  may  be  said  to  have  its  beginning  after 
a  crisis.  When  the  storm  broke,  all  who  could  fled  to  cover.  De- 
positors withdrew  their  funds;  the  banks  recalled  their  demand 
loans,  and  thus  eliminated  other  deposits  which  were  based  on  the 
credit  of  these  loans;  operators  in  real  estate  and  securities,  who 
were  unprotected  with  wide  equities,  were  forced  to  sell  to  those  with 
ample  capital;  also  manufacturers  and  middlemen  who  were  over- 
stocked in  anticipation  of  an  increasing  demand  at  higher  prices. 
In  all  quarters  speculative  profits  and  other  more  substantial  wealth 
were  parted  with  for  what  they  would  bring  to  save  a  modest 
remnant  from  like  disaster.  And  so  there  was  a  great  shifting  of 
wealth  from  the  weak  and  improvident  many  to  the  strong  and 
prescient  few. 

1445.  Now  as  the  business  cycle  begins  anew  there  comes,  in  the 
slow  and  dispiriting  process  of  recovery,  an  economic  regeneration. 


BOND  PRICES  IN  RELATION  TO  THE  TRADE  CYCLES    481 

The  country  is  in  its  best  condition  of  credit.  Capital  is  once  more 
in  stable  equilibrium.  Feebly  supported  enterprises  have  already 
gone  down  and  new  enterprises  are  not  yet  undertaken.  The  house- 
holder retrenches;  the  merchant  sells  his  stock  and  makes  few 
replacements;  the  manufacturer  runs  his  mill  on  part  time,  with  a 
reduced  force,  working  at  lower  wages.  The  efficient  workmen  are 
retained  and  the  less  productive  are  eliminated. 

1446.  On  all  sides,  people  are  earning  less  and  spending  less.  But 
there  is  this  difference  between  their  surplus  now  and  their  surplus 
before  the  panic:  what  they  have  now  they  keep  in  practically 
liquid  state,  or  it  is  invested  strictly ;  it  is  not  sunk  into  speculative 
ventures  simply  on  the  promise  of  future  returns.  Fear  and  un- 
certainty have  chilled  the  speculative  fever  and  driven  the  lifeblood 
of  money  and  credit  nourishing  new  enterprises  back  to  the  heart 
of  the  great  financial  body,  the  banking  center. 

1447.  Funds  now  begin  to  accumulate  at  the  banks  in  embarass- 
ing  amounts;  and  the  banks  in  turn  are  obliged  to  find  outlets  for 
the  employment  of  these  deposits  that  they  may  pay  interest  on 
them.  The  situation  of  the  banks  is  also  the  situation  that  con- 
fronts most  moneyed  men,  institutions,  and  corporations.  The 
great  jobbers  have  withdrawn  from  the  mills  their  orders  for  new 
goods,  and  they  will  not  renew  these  orders  until  they  have  mar- 
keted their  present  stock.  Meanwhile  their  idle  funds  are  put  into 
loans.    Everybody  likes  to  get  the  "  feel  "  of  his  money. 

1448.  Naturally,  the  first  interest  to  revive  under  the  stimulus 
of  idle  funds  is  the  investment  interest.  Stocks,  to  be  sure,  have  an 
immediate  rebound,  after  the  panic — in  fact  usually  in  the  afternoon 
of  the  panic  day — but  this  is  purely  the  result  of  the  mechanism 
of  the  exchange.  A  study  of  prices  will  show  that  in  proportion  to 
the  decline,  the  early  recovery  of  bonds  is  much  greater.  By  a 
glance  at  the  chart  it  will  be  seen  that  early  in  January,  1908,  listed 
railroad  bonds  at  New  York  had  recovered  one-half  of  all  they  had 
lost  during  the  preceding  year  culminating  in  the  crisis  of  Novem- 
ber; but  during  that  same  period  of  revival,  from  November  to 
January,  stocks  recovered  only  one-fifth  of  their  loss. 

1449.  As  long  as  the  investment  demand  predominates  over  the 
speculative  demand  bonds  will  continue  to  rise  in  price,  although 
the  advance  may  be  checked  from  time  to  time  by  too  liberal  offers 
of  new  securities.  But  eventually  the  business  world  will  recover, 
by  its  saving,  from  the  financial  debacle  of  the  crisis,  and  take 
courage  to  launch  new  enterprises  and  to  assume  risks.    Then  cash 


482    BOND  PRICES  IN  RELATION  TO  THE  TRADE  CYCLES 

deposits  in  banks  will  tend  to  fall  off,  and  the  banks  will  be  called 
upon  to  make  loans  to  customers,  who  for  some  lime  past  have 
been  their  heavy  creditors.  But  these  loans,  in  part,  will  be 
credited  to  the  customers  as  deposits  and  will  have  a  purchasing 
power  equivalent  to  a  like  amount  of  gold.  Banks  which  first  feel 
the  drain  of  commercial  demand  will  borrow  of  other  institutions 
for  a  time,  in  order  to  meet  their  need  for  funds;  but  as  the  securi- 
ties they  bought  after  the  panic  appreciate,  and  thus  decrease  the 
net  income  on  current  selling  prices,  and  as  the  rate  of  interest 
they  can  command  on  commercial  paper  loans  increases,  there  comes 
a  time  that  banks  begin  to  sell  securities  to  strengthen  reserves. 

1450.  Soon  after  this  period  in  the  trade  cycle,  when  business 
resumes  a  normal  condition,  the  slower-moving,  speculatively  in- 
clined private  investor  sees  opportunity  to  make  more  than  an 
investment  return  by  buying  real  estate  or  commodities  (which 
have  not  yet  risen  in  price  materially)  in  anticipation  of  a  coming  in- 
sistent demand.  He,  too,  takes  his  investment  profits  to  put  his  cap- 
ital with  its  recently  acquired  increment  into  forms  of  purchase  with 
greater  speculative  possibilities  than  bonds  yield  at  the  high  level. 
Thus  the  process  of  distribution  in  bonds  takes  place  during  tlve 
process  of  elevation  in  stocks  and  during  the  process  of  accumula- 
tion in  commodities  and  real  estate. 

1451.  The  Eelation  of  Bond  Prices  to  the  Condition  of  Credit.  As 
related  to  bond  prices,  the  argument  of  the  business  cycle  amounts 
to  this:  the  prices  of  current,  high  grade,  listed  bonds  (and  of  other 
bonds  in  their  degree)  depend  on  the  condition  of  general  credit. 
The  proof  of  it  is  strikingly  evident  in  Chart  XVI,  which  shows 
that  the  average  price  of  the  10  bonds  with  which  we  have  been 
dealing,  varies  inversely  as  the  ratio  of  loans  to  deposits  in  the 
national  banks  of  the  United  States.1  This  statement  may  seem 
difficult  of  understanding  at  first,  but  the  fact  is  very  simple. 

1452.  The  national  banks  of  the  country  are  the  clearing  houses  of 
commercial  and  personal  credit.  Loans  represent  the  demand  for, 
and  deposits  represent  the  supply  of  general  credit.  The  ratio  of  loans 
to  deposits,  therefore,  is  the  ratio  of  the  demand  for  to  the  supply 
of  credit ;  it  is  the  index  of  the  condition  of  credit.  High  ratio  means 
necessity  for  liquidation  by  borrowers;  low  ratio,  power  for  accumu- 
lation. These  statements  holds  in  spite  of  the  fact,  already  noted, 
that  the  shifting  of  a  bank's  customers  from  a  credit  to  a  debit 

1  The  indexes  for  the  ratios  are  compiled  from  the  reports  of  the  Comptroller  of  the 
Currency.     The  information  is  available  five  times  a  year. 


BOND  PRICES  IN  RELATION  TO  THE  TRADE  CYCLES     483 


Chart  XVI 

1.  Railroad  Bond  Prices— Relative  Index  Numbers  (Average  18*8-1907=100  Per  Gent.) 

2.  Ratios  of  Loans  to  Deposits— All  National  Banks  of  the  United  States- 

Relative  Index  Numbers  (Average  1898-1907=100  Per  Gent.) 

I  2 


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•Periods  Irrluded  In  weeks  ended  Friday  during  each  Calendar  HBMfc 
A  Composite  of  Charts  that  are  copyright,  1910,  by  the  Financial  Graphic  Oo. 


120% 


aMISICatf  S»A«  ■  OT»  CO     ■   I 


BOND  PRICES  IN  RELATION  TO  THE  TRADE  CYCLES 

position  may  be  accomplished  without  corresponding  bookkeeping 
loss  in  the  item  of  deposits.  The  weakened  position  may  show  more 
in  the  loans. 

1453.  When  borrowers  must  liquidate,  the  prices  of  all  things 
purchasable  that  have  a  national  market  must  fall.  The  fall  may 
be  delayed  so  long  that  the  cause  is  obscured;  but  sooner  or  later 
ii  must  come.  Therefore,  a  high  ratio  of  loans  to  deposits  means 
low  prices  for  bonds,  stocks,  and  commodities  in  general ;  and  the 
effect  of  high  prices  is  usually  felt  in  this  order  for  reasons  outlined 
in  the  pages  immediately  preceding. 

1454.  But  bond  prices  have  a  much  more  intimate  relation  to 
credit  than  do  either  stock  or  commodity  prices.  Bonds,  themselves, 
are  credit  instruments  for  loans,  and  such  bonds  as  are  chosen  for 
graphic  study  here  are  long-term  credit  instruments.  High  grade 
as  they  are,  and  listed,  and  fairly  active  on  the  principal  exchanges, 
they  respond  quickly  to  alterations  in  the  condition  of  credit;  their 
movements  are  less  hampered  by  extraneous  circumstances,  are  little 
affected  by  fears  for  the  safety  of  interest,  or  principal  at  maturity. 

1455.  The  financing  of  the  bond  business,  and  of  bond  speculation 
in  general,  is  another  aspect  of  the  same  relationship  between  prices 
and  credit.  When  credit  is  cheap,  bonds  may  be  bought  and  carried 
on  loans  that  will  cost  less  than  the  income  or  interest  from  the 
bonds.  Bonds  will  therefore  be  in  demand  for  the  sake  of  this  dif- 
ference, and  the  logical  appreciation  which  this  difference  should 
cause,  in  the  long  run.  When  there  is  no  profit  in  thus  carrying 
bonds,  speculative  holdings  will  be  liquidated  and  bond  prices  will 
fall. 

1456.  For  the  several  reasons  mentioned  the  reciprocal  relation 
subsisting  between  the  price  of  credit  and  the  price  of  other  pur- 
chasables,  such  as  commodities,  stocks,  and  bonds,  is  most  intimate 
in  the  case  of  bonds.  This  relationship  authorizes  a  generalization 
of  importance:  Because  the  condition  of  the  country's  credit  at 
large  is  not  a  thing  subject  to  market  manipulation,  the  movement 
in  listed  bonds  is  not,  in  general,  subject  to  manipulation. 

1457.  It  will  immediately  occur  to  many  that  the  10  active  listed 
railroad  bonds  of  the  chart  may  be,  as  to  movement,  representa- 
tive of  bonds  in  general ;  that  since  they  are  of  the  kind  that  metro- 
politan banks  and  insurance  companies  buy,  they,  of  all  bonds,  will 
be  most  sensitive  to  credit  conditions.  Only  one  of  these  10  issues 
is  among  the  dozen  now  most  active  on  the  New  York  Stock  Ex- 
change; but  still  the  principle  holds  that  the  movement  of  active 


BOND  PRICES  IN  RELATION  TO  THE  TRADE  CYCLES    485 

listed  bonds  reflects  credit  most  accurately;  and  if  the  movement 
in  active  and  inactive  unlisted  bonds,  particularly  municipals,  is  less 
sensitive,  nevertheless,  the  trend  of  it  is  of  vast  importance  and 
will  be  the  same  as  the  trend  of  the  listed. 

1458.  Since  there  has  been  established  this  very  helpful  relation 
between  the  price  of  listed  railroad  bonds  and  the  condition  of 
credit  as  expressed  in  the  ratio  of  loans  to  deposits  of  the  national 
banks  of  the  country,  the  natural  inquiry  is :  to  what  extent  can  the 
country's  credit  condition  be  forecasted?  The  writer  does  not  know 
whether  any  one  has  successfully  established  significant  statistical 
relations,  on  the  one  hand,  between  loans  and  the  undertaking  of 
new  enterprises,  and  on  the  other  hand,  between  deposits  and  the 
returns  from  enterprise.  But,  howsoever,  the  causes  of  credit  condi- 
tions are  very  complex  and  obscure  and  carry  us  too  far  afield  to 
warrant  further  capitulation  here.  Still,  it  would  be  false  reti- 
cence not  to  mention  that  the  Financial  Graphic  Company  have 
drawn  a  graph,  based  on  certain  fundamental  conditions,  that 
anticipates,  and  therefore  prophesies  stock  and  bond  prices.  From 
a  financial  point  of  view  it  is  the  most  important  chart  ever  pub- 
lished. 

1459.  The  Curve  of  Bond  Prices  in  Elevation  and  Depression.  The 
third  phenomenon  of  bond  price  movement  to  which  attention  has 
been  called  is  the  acuteness  of  the  depression  in  time  of  panic  and 
the  gradualness  of  advance  and  subsequent  decline  at  the  high  levels 
attained  on  the  resumption  of  general  business  speculation.  This 
phenomenon  is  somewhat  true  of  stock  price  movements,  but  in  not 
so  marked  a  degree.  It  is  not  true  at  all  of  commodity  prices ;  but 
it  has  not  been  thought  necessary  to  insert  a  15-year  commodity 
chart  in  support  of  the  statement. 

1460.  In  seeking  a  convincing  explanation  of  what  may  be  called 
the  scallop  of  bond  prices,  two  facts  must  not  be  lost  sight  of: 
securities  are  not  consumed  like  many  commodities;  and  they  have 
a  fairly  fixed  intrinsic  worth  to  be  distinguished  from  their  market 
value. 

1461.  Most  goods  have  a  seasonable  or  fashionable  value  out  of 
all  proportion  to  their  merits  as  necessities.  Fruits,  furs,  and  auto- 
mobiles, and  articles  generally  which  are  perishable  or  dependent 
upon  the  caprices  of  vogue,  have  a  value  strictly  subject  to  the  laws 
of  more  or  less  immediate  supply  and  consumptive  demand.  If  the 
supply  should  be  at  any  time  in  excess  of  the  consumptive  demand, 
the  fall  in  value  would  not  be  tempered  to  any  great  extent  by  the 


48t>    BOND  PRICES  IN  RELATION  TO  THE  TRADE  CYCLES 


Chart  XVII 

FUNDAMENTAL  CONDITIONS  IN  THE  UNITED  STATES 
Tbe  Financial  Graphic  Index  of  Fundamental  Conditions 


«■■■>»■■  UNI  MOM  U>  ...  i 


Normal     zero  (o);  above  normal  as  plus  (  +); 
below  normal  =■  minus  (— ) 

'1st  Kit 

2d  Mo. 

Jd.Mo. 

— -10        —20         0         +20        +40 

'96 

1st  qr 

—  9.3 

—  9.0 

-    l.-j 

^> 

id     " 

-    5.4 

-  2.2 

-  3.5 

> 

3d    " 

—   6.1 

—25.9 

-  20.5 

«C 

4th  " 

—  17.5 

+    1.8 

+  16.8 

'97 

In  qr 

+  20.6 

+  20.4 

+  23.8 

2d     " 

t  2U.1 

+  17.7 

+  18.6 

3d    " 

+  19.9 

+  16.9 

+  13.K 

4th  " 

+   9.1 

+  19.8 

+  18.8 

'98 

1st  qr 

+  18.1 

+  16.5 

+   8.7 

3d    " 

+  3.5 

+   8.8 

+  20.9 

3d    " 

+  20.4 

M/.6 

+  10.8 

4th  " 

+  21.1 

+  25.6 

+  27.4 

'99 

1st  qr. 

+  24.6 

+  20.1 

+  15.6 

2d    " 

+  13.1 

+  14.3 

+  16.1 

3d    " 

+  7.7 

+   3.9 

+   1.4 

4th  " 

-  3.1 

-  4.0 

-  1.4 

•00 

1st  qr. 

—  2.5 

+   2.6 

+    1.1 

2d    " 

+  6.3 

+   9.3 

+  6.0 

3d    " 

+  6.7 

+  8.2 

+  12.3 

4th  " 

+    4.0 

+   7.7 

+   7.3 

'01 

1st  qr. 
2d    " 

+  8.7 

+  10.6 

+  15.0 

+  7.7 

+   2.7 

+   2.2 

3d    " 

+   0.9 

+   2.7 

+  3.7 

4th  " 

+  7.7 

+   9.5 

+  5.4 

'02 

1st  qr. 

+    1.4 

+   3.9 

+  3.9 

2d    " 

+  1.5 

-  2.3 

-  3.1 

3d    " 

-  2.3 

-  2.6 

-  8.7 

4th  " 

—  6.9 

-   0.4 

-  3.7 

'03 

1st  qr. 

—  4.6 

-  5.2 

-  8.7 

2d    " 

—  8.9 

—  7.0 

—  13.4 

3d    " 

—  12.4 

—  10.4 

-  6.1 

4th  " 

-  3.7 

—  6.9 

-  4.0 

'04 

1st  qr. 

+  0.1 

+   0.8 

+   8.0 

^ 

2d     " 

+  12.0 

+  10.2 

+  13.4 

<s 

3d    " 

+  18.7 

+  20.9 

+  21.3 

4th  " 

+  17.3 

+  17.1 

+  15.1 

'05 

1st  qr. 

+  12.4 

+   9.4 

+  11.3 

2d    " 

+  7.9 

+   5.6 

+   2.8 

3d    •' 

+  4.8 

+  4.9 

+  3.3 

4th  " 

—  0.4 

-  3.3 

—  4.2 

'06 

1st  qr. 

—  9.3 

-12.3 

-11.3 

2d    " 

—  12.7 

-13.1 

-13.6 

3d    " 

—13.4 

-14.6 

-15.1 

4th  " 

—  10.9 

-13.0 

-15.5 

'07 

1st   .|r. 

-18.2 

-20.1 

—  19.2 

2d    " 

—  12.3 

—  1X9 

-18.2 

^ 

3d    •' 

-20.1 

-22.0 

-15.8 

. 

r 

4th  " 

—  18.2 

-30.1 

-25.5 

< 

'08 

1st  »|r. 

—  13.5 

—  5.7 

+   0.4 

2d    " 

+   6.2 

+  10.5 

+  10.6 

3d    " 

+  12.3 

+  15.5 

t   20.1 

•1th  " 

+  17.8 

+  18.4 

+  17.1 

•09 

1st  qr. 

+  11.3 

+   7.4 

+  12.5 

< 

2d    " 

<  in 

+   8.1 

+   6.4 

? 

3d    " 

+   9.4 

+  4.1 

+   3.8 

? 

4th  " 

-   2.4 

-  3.7 

-  2.9 

< 

'10 

1st  qr. 

-  6.3 

-  6.4 

-  4.5 

< 

id     " 

-  8.6 

-11.0 

-11.1 

r 

3d     " 

—  11.9 

-  5.1 

-   3.8 

s 

1th  '• 

—   6.7 

-  4.8 

»     O.N 

S 

—20         0       +20        +40 
•Psriods  Included  In  weeks  ended  Friday  during  each  C"1*"tirr  month. 
+  As  on  the  dates  covered  by  tbe  repoits  of  the  Comptroller  of  the  Currency. 
Copyright,  1910,  Financial  Graphic  O 


BOND  PRICES  IN  RELATION  TO  THE  TRADE  CYCLES     487 

advent  of  the   speculative  demand   which   anticipates   subsequent 
higher  prices. 

1462.  Bonds,  however,  have  an  investment  value  distinct  from 
their  market  value.  The  fact  has  already  been  emphasized  as 
strongly  as  possible  in  these  pages.  This  investment  value  may  be 
expressed  as  the  rate  per  cent,  the  interest  of  the  bond  yields  at 
the  price  paid,  assuming  that  the  bond  is  to  be  held  to  maturity. 
One  reason  that  the  course  of  stock  prices  does  not  follow  so  mark- 
edly the  "  scallop  "  is  because  the  income  from  stocks,  at  the  price 
paid  (i.e.  their  investment  value),  may  be  reduced  in  a  period  of 
depression  by  a  reduction  or  cessation  of  dividends;  and  just  as 
manipulation  delays  their  decline,  this  uncertainty  delays  their  re- 
covery, and  makes  it  spasmodic. 

1463.  Since,  then,  the  supply  of  bonds  will  not  be  consumed  like 
commodities,  and  the  increase  in  the  supply  is  fairly  predicable, 
and  since  there  is  nothing  that  has  a  more  stable  investment  value, 
bonds,  which  suffer  in  value,  like  everything  else  in  the  crisis,  will 
rise  most  quickly  and  proportionately  immediately  afterward. 

1464.  Although  the  trend  of  bonds  turns  downward  while  all 
things  else  are  on  the  upturn,  yet  the  course  of  "  hesitation  "  and 
descent  is  more  gradual  than  that  of  stocks.  The  credit  situation 
of  the  banks  changes  surely,  but  very  slowly,  and  it  takes  months 
and  sometimes  years  for  the  demands  of  business  to  create  a  money 
tension  sufficient  to  force  the  banks  to  sell  their  marketable  se- 
curities. 

1465.  It  might  have  been  mentioned  earlier  in  this  discussion 
that  some  of  the  same  reasons  which  produced  an  early  demand 
for  bonds,  after  a  crisis  caused  the  highest  grades  of  bonds  first  to 
receive  an  upward  impetus.  When  confidence  begins  to  return  it 
seizes  upon  the  most  conservative  investment  channel,  namely  bonds ; 
and  upon  the  highest  grade  of  bonds.  Then,  when  the  outlook  is 
brighter,  purchasers  are  not  content  with  the  low  return  of  the 
highest  grade,  and  will  accept  bonds  of  second  grade.  During  the 
more  prosperous  and  speculative  times  which  follow,  when  all  cor- 
porations show  comparatively  heavy  earnings,  attention  is  turned 
to  industrial  obligations.  The  order  of  bonds  price  revival  is  the 
order  of  bond  merit. 

1466.  Likewise  when  the  time  comes  for  bank  liquidation  in 
bonds,  it  is  the  bonds  of  highest  grade  which  are  first  sold,  for 
there  is  least  income  in  holding  them,  and  most  profit  in  realizing 
on  them.    Moreover  the  future  looks  bright,  and  it  seems  safe  to  hold 


488    BOND  PRICES  IN  RELATION  TO  THE  TRADE  CYCLES 

to  inferior  bonds  of  superior  income.  The  buying  of  commercial  cor- 
porations and  of  individuals  depends  for  its  breadth  not  so  much 
upoD  banking  as  upon  commercial  conditions,  so  far  as  the  two 
may  be  distinguished.  Individuals  and  commercial  corporations  are 
just  beginning  to  reap  profits  from  general  business  to  put  into 
bonds.  Consequently,  for  a  lime,  general  investment  buying  sup- 
ports "on  a  scale  down"  the  liquidation  of  institutions.  It  is  not 
until  another  crisis  is  plainly  imminent  that  bonds  for  which  there 
is  a  free  market  are  left  for  a  brief  period  utterly  to  the  mercies 
of  the  bargain  hunter  who  buys  for  profit,  primarily,  rather  than 
for  income. 

1467.  The  Range  of  Stock  and  Bond  Fluctuations.  Fourthly,  as  to 
the  relative  range  of  stock  and  bond  fluctuations, — it  is  this  bargain 
hunter,  however,  who  by  discretion  in  the  time  of  his  purchase  adds 
to  the  security  of  liquidation  of  his  invested  principal.  It  is  not  to 
be  expected  that  the  range  of  fluctuation  in  bonds,  the  prime  invest- 
ment paper,  will  compare  favorably  with  the  range  in  stocks,  the 
speculative  paper  par  excellence.  The  respective  ranges  of  the  two 
since  the  panic  of  1907  have  been  as  one  is  to  seven.  That  is,  based 
on  100  as  the  15-year  price  average,  bonds  have  risen  from  the  non- 
seasonal  index  number  91.54  in  November,  1907,  to  99.99  in  Decem- 
ber, 1908, — a  gain  of  about  8£  points;  and  stocks  have  risen  from 
the  index  number  89.25  in  November,  1907,  to  a  high  point  in 
August,  1909,  of  148.13,  or  about  58f  points. 

1468.  Viewed  as  a  matter  of  prices,  the  gain  from  panic  bond 
buying  during  the  last  25  years  is  very  clear.  A  New  York  banking 
house  finds  that  a  dozen  or  more  representative  listed  railroad 
bonds  rose  from  the  June  low  prices  during  the  panic  of  1884,  8£ 
points  before  the  close  of  the  year,  and  over  17  points  during  the 
following  year.  The  low  prices  in  the  panic  of  1893  were  made 
mostly  in  August.  Before  the  new  year  prices  had  risen  an  average 
of  nearly  10  points,  and  during  1894  they  had  risen  about  li-\  points 
more. 

1469.  The  monetary  panic  of  1903  was  by  no  means  a  country- 
wide liquidation,  and  general  banking  credit  was  not  severely 
strained;  therefore  the  recovery  from  August  low  prices  acquired 
before  January  was  less  than  4^  points,  and  the  advance  during 
1904  was  only  about  3£  points  additional,  or  8\  points  in  all. 

1470.  If  we  take  for  similar  computation  the  prices  attained 
by  the  10  railroad  bonds  which  are  the  basis  for  most  of  our 
graphs  of  bond  prices,  the  results  for  the  1903  panic  are  about 


BOND  PRICES  IN  RELATION  TO  THE  TRADE  CYCLES     489 

the  same.     Perhaps  something  will  be  gained  by  presenting  the 
tables  in  detail,— not  only  for  1903,  but  for  1907 : 


Atchison,  Topeka  &  Santa  Fe 
General  4s  of  1995 

Chesapeake  &  Ohio  : 

First  Consol.  5s  of  1939.... 


Chicago,  Milwaukee  &  St.  Paul 

Gen.  Mortgage  "A"  4s  of  1989 
Louisville  &  Nashville : 

Unified  4s  of  1940 

Missouri,  Kansas  &  Texas: 

First  4s  of  1990 

N.  Y.  Central  &  Hudson  River  : 

West  Shore  Guar.  4s  of  2361 . . 
Norfolk  &  Western  Ry. : 

First  Consol.  4s  of  1996 

Northern  Pacific: 

Prior  Lien  4s  of  1997 

Reading: 

General  4s  of  1997 

Union  Pacific: 

First  Mortgage  4s  of  1947 


1903 
Low 

1904 
High 

Ad- 
vance 

1907 
Low 

Oct.    97£ 

Sep.  104 

6* 

Nov.  89£ 

Nov.  114 

Oct.  120* 

H 

Nov.  101 

Aug.  103 

Dec.  112 

9 

Nov.  98 

Aug.  97| 

Dec.l04f 

71 

Nov.  92 

July  95 

Nov.  103 

8 

Oct.  89i 

Oct.   106 

Dec.  110* 

H 

Nov.  94 

Oct.   94f 

Sep.l02f 

8* 

Nov.  86 

Aug.  99| 

Dec.  106 

H 

Oct.  93| 

July  93f 

Dec.l03i 

9f 

Oct.  86| 

Sep.  99£ 

Dec  107* 

8f 

Oct.  92f 

1908 
High 


Dec.  101} 

Oct.  116$ 

Nov. 

Dec.  1044, 
Dec.  103 

Nov.  101 

Dec.  105 

Sept.   99f 

Sep.  104i 

Dec.  102| 

Dec.  105 


Ad- 
vance 


11 
11 


16 


Average. 


.7.45 12.01 


1471.  The  Present  Trend  of  Bond  and  Stock  Prices.  It  is  a  curious, 
but  significant  fact,  that  although  the  courses  of  bond  and  stock 
prices  over  the  past  15  years  have  shown  sufficient  similarity  in 
trend  to  indicate  that  from  crisis  to  crisis  they  are  affected  by  similar 
sets  of  influences,  nevertheless,  during  the  past  10  years  stocks  have 
displayed  a  "  buoyancy  "  that  has  no  correspondence  in  bonds. 

1472.  The  high  point  in  stocks  in  1902  (as  shown  in  chart)  was 
greatly  exceeded  in  the  next  period  of  prosperity,  culminating  in 
1906,  and  the  higher  level  of  prices  in  1906  was  maintained  for  a 
somewhat  longer  period  than  the  lower  level  of  high  prices  in  1902. 
The  high  prices  of  the  prosperous  year  1909  have  not  quite  attained 
the  level  of  1906,  but  inasmuch  as  1909  prices  prevailed  in  a  period 
of  business  activity  which  cannot  be  called  unduly  speculative, — 
at  least  in  the  same  degree  as  that  of  1905-06, — it  seems  probable 
that  an  old-fashioned  bull  market  would  carry  the  line  to  a  new 
high  point.  Again,  the  low  prices  of  the  panic  of  1903  are  far 
above  the  prices  of  1900,  and  although  the  1903  low  level  was  almost 
reached  in  the  panic  of  1907,  it  was  for  the  briefest  possible  time. 
The  reaction  was  more  abrupt  than  the  decline. 

1473.  The  high  point  reached  by  bonds  between  1900  and  the 
panic  of  1903  was  not  quite  reached  by  the  high  point  between 


490     BOND  PRICES  IN  RELATION  TO  THE  TRADE  CYCLES 

1903  and  1907,  and  thus  far  since  the  last  panic  the  price  curve 
gives  every  indication  of  a  shift  to  lower  levels  than  have  prevailed 
for  a  decade.  The  low  point  of  the  panic  of  1903  seems  high  com- 
pared with  the  low  point  of  the  panic  of  1907;  and  indeed,  not  much 
lower  than  the  recent  high  point. 

1474.  The  question  naturally  arises,  why  should  these  two  classes 
of  securities,  which  show  the  same  general  trend  between  1800  and 
1900,  and  which  have  secondary  or  cyclic  movements  of  the  same 
general  character,  show  a  recent  marked  tendency  to  diverge  in  the 
general  trend?  As  to  bonds,  part  of  the  answer  is  involved  in  the 
diminishing  return  which  results  from  advancing  prices.  But  other- 
wise, the  same  conditions  to  which  we  have  attributed  the  long  up- 
lift have  been  more  favorable  to  high  bond  prices  since  the  turn  in 
1902  than  previously.  Therefore,  the  other  influences  accomplishing 
this  reversal  of  trend  must  be  looked  into.  They  must  be  cogent 
for  they  have  predominated  over  conditions  which  we  have  found 
of  no  mean  growth  and  weight. 

1475.  In  the  next  chapter,  then,  we  shall  cautiously  put  out  a 
few  lines  of  thought  in  an  attempt  to  explain  the  recent  trend  of 
bond  prices  for  the  help  such  an  attempt  may  be  in  appraising  the 
new  primary  price  movement  that  appears  to  have  set  in. 


CHAPTER  XXXIX 
THE  FUTURE  OF  BOND  PRICES 

1476.  We  come  now  to  the  most  important  matter  involved  in 
the  course  of  bond  prices.  Are  we  to  expect  that  the  security  of 
principal  invested  at  the  present  price  levels  will  be  hazarded,  over 
the  coming  decades,  by  a  reversal  of  the  conditions  that  for  50  years 
have,  in  the  main,  been  favorable  to  long-term  loans  at  interest  in 
this  country?  And  will  the  interest  on  this  principal  be  worth  less 
to  us,  and  therefore  its  security  be  impaired,  because  of  a  future 
decreased  purchasing  power  ?  It  is  important  to  know.  The  interest 
of  a  20-year  5  per  cent,  bond  is  of  much  more  value  than  the  prin- 
cipal. 

1477.  The  Prospect  of  Advance.  A  glance  at  the  chart  of  Railroad 
Bond  prices  will  recall  that  from  1899  to  the  present  the  standard 
funded  loans  have  been  at  an  unprecedentedly  high  level.  In  1899 
the  upward  trend  of  the  four  characteristic  railroad  bonds  *  had 
carried  them  to  such  a  point  that  they  yielded  only  about  3.80  to 
3.85  per  cent.  In  1856,  the  shorter  term  bonds  that  were  the  basis 
of  the  chart  for  the  early  years  2  yielded  about  7.55  per  cent.,  or 
approximately  twice  as  much. 

1478.  It  needs  no  chart  nor  figures  to  inform  us  that  any  great 
elevation  in  price  level  over  that  which  has  prevailed  for  the  past 
10  years  must  be  slight  and  transitory.  For  the  indefinite  future 
a  return  averaging  at  least  4  per  cent,  will  probably  be  demanded 
of  money  to  the  loan  of  which  there  is  attached  a  commercial  risk. 
The  closer  the  approach  to  zero  the  greater  the  resistance  encount- 
ered to  further  lowering  of  the  return,  or  to  further  increase  in  the 
price. 

1  Chesapeake  and  Ohio  First  Consolidated  5s  of  1939. 

Chicago,  Milwaukee  and  St.  Paul  General  Mortgage  "A"  4s  of  1989. 

Louisville  and  Nashville  Unified  4s  of  1990. 

New  York  Central  and  Hudson  River,  West  Shore  Guaranteed  4s  of  2361. 

2  Erie  First  Mortgage  7s  of  1868. 

Chicago,  Rock  Island  and  Pacific  First  Mortgage  7s  of  1870. 
Illinois  Central  First  Mortgage  7s  of  1875. 
New  York  Central  Premium  6s  of  1883. 

491 


492  THE  FUTUKE  OF  BOND  PRICES 

1479.  The  Prospect  of  Decline.  If  bond  prices  cannot  advance 
materially,  are  the  prospects  good  that  they  will  hold  their  own,  or 
are  we  likely  to  see  material  declines  ?  There  is  great  difference  of 
opinion  and  nothing  but  time  can  decide.  Meanwhile  a  clear  out- 
line of  the  principal  forces  at  work  determining  the  long  trend  of 
bond  prices  may  quiet  the  misgivings  of  some  who  now  fear  to  buy 
long-term  bonds  lest  they  might,  in  the  future,  be  unable  to  realize 
without  great  sacrifice  when  in  need  of  funds,  or  lest  the  income 
from  their  bonds  should  so  diminish  in  purchasing  power  as  to  be 
insufficient  for  their  needs. 

1480.  We  have  concluded  that  the  principal  forces  making  for  the 
long  and  steady  increase  in  American  bond  values  were  increase  in 
bond  security  achieved  with  the  growth  and  development  of  our  na- 
tional resources  of  all  kinds,  and  increase  in  the  demand  for  bonds, 
due  to  our  growth  in  surplus  wealth.  If  anything  is  certain,  these 
forces  will  continue  for  an  indefinite  period  to  operate  in  favor  of 
good  bond  prices.  If  the  bond  price  chart  shows  a  slightly  down- 
ward tendency  at  present,  it  must  be  due,  not  to  weakness  in  this 
uplifting  power,  but  to  preponderance  of  the  depressing  power,  for 
otherwise  the  stock  price  chart  would  show  a  downward  trend  for 
the  last  decade — which  it  does  not. 

1481.  Conceding,  then,  that  material  prosperity  works  toward  con- 
tinuance of  good  bond  prices,  there  is  nothing  seriously  proposed 
but  the  decline  in  the  value  of  money  itself,  which  can  permanently 
lower  the  value  of  bonds.  A  $1000  bond  bearing  5  per  cent,  interest 
yields  $50  a  year.  If  20  years  from  now  that  $50  will  purchase 
only  what  $30  does  now,  or  if  the  bond  then  matures,  and  the  $1000 
will  purchase  what  $600  does  now,  obviously  the  fact  will  have  a 
depressing  tendency  on  bond  prices  meanwhile. 

1482.  The  Increasing  Annual  Output  of  Gold.  As  regards  bond 
prices  this  is  substantially  the  position  of  those  who  see  in  the  re- 
cent great  increase  in  the  annual  production  of  gold  an  oversupply 
with  consequent  depreciation  of  the  money  unit,  or  standard  of  value. 
If  there  lurks  a  fallacy  in  their  theory  it  is  desirable  to  bring  it  out 
of  hiding,  for  within  the  past  three  years  the  doctrine  of  depreciation 
has  got  such  a  foothold  in  scholastic  and  investment  circles,  that 
many  who  have  hitherto  bought  bonds  have  been  led  astray  into 
speculative  ventures.  To  some  of  them  a  day  of  reckoning  will  come 
when  they  will  realize  that  it  is  no  longer  a  theory  but  a  condition 
that  confronts  them. 


THE  FUTURE  OF  BOND  PRICES 
Chart  XVIII 

GOLD 

1.  U.  S.  Gold  Production 

2.  World  Gold  Production 


493 


i  1   la 

Tkoiuuds  of  Ouoces 

( 

■aler.te 
Years 

' 

6500 

1856 

1  MM 

6500 

1857 

1 

2418 

6500 

1858 

1 

f                            -2 

2418 

6500 

1859 

1 

2225 

6500 

1860 

J 

1 

2080 

5950 

1861 

/            / 

1896 

5950 

1862 

/            1 

1935 

5950 

1863 

\             ■ 

22J0 

5950 

1864 

\           1 

2574 

5950 

1865 

\ 

2588 

6250 

1866 

V 

2502 

6250 

1867 

1 

2322 

6250 

1868 

J 

r              i 

2394 

6250 

1869 

i 

2418 

6250 

1870 

i 

2104 

5580 

1871 

/ 

/ 

1741 

5580 

1872 

/ 

1741 

5580 

1873 

1620 

5580 

1874 

1619 

5580 

1875 

1931 

5540 

1876 

2268 

5540 

1877 

"\          ! 

2477 

5540 

1878 

\          | 

1881 

5540 

1879 

/ 

1741 

5540 

1880 

/            ! 

1673 

4800 

1881 

/          / 

1572 

4800 

1882 

/           ■ 

1451 

4800 

1883 

1489 

4800 

1884 

1 

1538 

4800 

1885 

1 

1686 

5470 

1886 

1603 

5470 

1887 

1 

1604 

5470 

1888 

1 

1594 

5470 

1889 

1 

1588 

5470 

1890 

1 

1604 

6320 

1891 

N. 

1597 

7094 

1892 

\ 

1739 

7618 

1893 

\ 

1910 

8764 

1894 

\                   \. 

2254 

9615 

1895 

\                     s- 

2568 

9783 

1896 

\                       \ 

2774 

11420 

1897 

\                        *^- 

3118 

13877 

1898 

\                             — . . 

3437 

14837 

1399 

\                                       -s, 

3829 

12315 

1900 

\                       --* 

3805 

12625 

1901 

3870 

14354 

1902 

^.^^ 

3560 

15852 

1903 

~7 

"N.. 

3892 

16804 

1904 

\                   v- 

4265 

18268 

19*5 

\                    "^ 

4565 

19366 

1906 

\ 

4335 

11860 

1907 

'/ 

4659 

21378 

1908 

\                                      "^ 

4800 

22300 

1909 

}                                                 N 

4614 

22025 

1910 

/ 

1911 

1912 

._  A»£filC*t*BAIII  NOUCO.JUt 


494 


THE  FUTURE  OF  BOND  PRICES 


Chart  XIX 


COMMODITY  PRICES 

1.  Brad  street's  Index  Number 

2.  Dun's  Index  Number 

3.  Commodity  Prices  in  Terms  of  Gold 


1 

1      2 

3     1 

Dollar* 

takodar  Year 
Average! 

1856 

18.S7 

i«r.<t 

1859 

118.319 

1860 

109.867 

1801 

y 

125.829 

111.16 

1862 

\    —.2 

174.419:119.39 

1863 

249.229 

122.11 

1864 

229.675 

145.64 

1865 

--^                                 Jf 

206.779 

116.03 

1866 

192.801 

139.10 

1867 

*                  ^* 

;s6.5l<. 

133.41 

1868 

/ 

170.395 

127.07 

1869 

/              ^" 

155.891 

135.68 

1870 

152.956 

136.82 

1871 

1              / 

153.777 

136.69 

1872 

1             j 

147.773 

129.63 

1873 

•            / 

143.155 

128.62 

1874 

/          / 

135.403 

117.84 

1875 

y  / 

120.371 

107.58 

1876 

v  --*- 

116.185 

no. ho 

1877 

C  / 

100.604 

99.80 

1878 

*** 

99.337 

1879 

C 

114.207 

1880 

\ 

115.781 

1881 

\ 

123.436 

1882 

*\ 

111.808 

1883 

^ 

102.225 

1884 

s 

93.811 

1885 

/ 

92.269 

1886 

i 

96.176 

1887 

\ 

98.188 

1888 

\ 

'11.682 

1889 

/ 

94.0.2 

1890 

v 

98.723 

1891 

\ 

7.7769 

90.7S5 

1892 

s 

7.5.524 

92.700 

1893 

y 

6.6    1. 

83.668 

1894 

\yT 

6.4346 

82.202 

1895 

J\ 

5.9124 

76.521 

1896 

/y 

4.1159 

75.187 

1897 

\f 

4.5713 

79.393 

1898 

\^ 

7.2100 

8:.. 510 

1899 

*V 

7.8S39 

93.526 

1900 

^N. 

7.5746 

95.853 

1901 

y 

7.8759 

100.407 

1902 

Y\ 

7.9,.M 

99.035 

1903 

7.9U7 

100.172 

,1904 

li2 

8.0987 

100.574 

1905 

\i 

8.4176 
8.9045 
8.0118 

105.348 

1906 

\. 

•108.279 

1907 

^ 

1908 

\jS 

8.5154 

1909 

x 

8.988* 

1910 

x 

1911 

•IM«*-nnrlnu««l.     ATaragn  to  Miiy  1 

1912 

(Mltaucui  itVNc  aorcco.N  f. 


THE  FUTURE  OF  BOND  PRICES  495 

1483.  There  can  be  no  gainsaying  that  for  the  past  two  decades 
the  annual  increase  in  production  of  gold  has  been  out  of  proportion, 
in  certain  countries,  to  the  increase  in  the  production  of  many  com- 
modities. In  the  case  of  such  commodities  as  meat  this  is  largely 
due  to  inevitable  constriction  of  areas  that  can  be  devoted  to  the 
production  of  these  commodities.  At  least  this  is  true  in  the  United 
States.  As  far  as  gold  itself  is  concerned,  the  increase  in  production 
is  due  largely  to  the  discovery  of  new  sources  of  supply  in  Alaska, 
Australasia,  South  Africa,  and  elsewhere;  but  more  particularly 
to  improvements  in  mining  methods  and  metallurgical  processes, 
which  materially  reduce  the  cost  of  production  and  therefore  make 
profitable  the  exploitation  of  large  bodies  of  low-grade  ore. 

1484.  The  invention  of  bucket  and  pump  dredges  to  shovel  and 
suck  up  gravel  from  sandy  river  beds  and  auriferous  beaches,  and  the 
application  of  the  dredge  method  to  arid  sand  plains  by  what  is  called 
"  paddock  dredging,"  enlarges  enormously  the  possibilities  of  profit- 
able gold  production  beyond  the  domain  of  ordinary  mining.  Hy- 
draulic and  dry-blowing  processes  are  better  known  gold  mining 
developments.  As  placer  and  rich  surface  deposits,  assaying  $25 
the  ton,  give  way  to  more  extensive  interior  work  on  low  grade  ma- 
terial yielding  from  $2  to  $4  the  ton,  the  gain  in  quantity  under 
cheapened  cost  more  than  compensates  for  the  loss  in  ore  quality; 
and  even  if  the  mines  were  all  exhausted,  very  probably  chemical 
and  engineering  improvements  would  suffice  to  make  profitable  the 
utilization  of  gold  in  sands  and  clays.  The  graphs  of  annual  gold 
production  for  the  United  States  and  for  the  world  since  1857 
(Chart  XVIII)  make  plain  the  results  of  recent  gold  mining  develop- 
ments. 

1485.  The  profit  on  gold  taken  from  the  Rand  district  is  said  now 
to  be  over  40  per  cent.  The  absolute  cost  of  mining  is  likely  to 
diminish  indefinitely,  rather  than  to  increase ;  and  since  the  supply 
of  visible  ore  is  larger  than  at  any  time  hitherto,  the  prospects  are 
that  the  annual  product  will  continue  to  increase,  indefinitely,  as 
long  as  manufactured  articles,  or  other  commodities,  will  not  yield 
nearly  equal  profit  from  production. 

1486.  Gold  is  now  the  accepted  medium  of  exchange  and  stand- 
ard of  value.  In  1871  silver  was  demonetized  in  Germany,  and 
about  the  same  time  in  the  Scandinavian  Kingdoms,  the  Nether- 
lands, and  France  and  the  other  states  in  the  Latin  Union.  In  1893, 
India  closed  her  mints  to  the  free  coinage  of  silver,  and  the  United 
States  repealed  the  Silver  Law.    Not  to  mention  other  countries  of 


496  Tin:  fpttke  of  bond  prices 

Europe,  Mexico,  the  great  producer  of  silver,  Japan,  and  a  ma- 
jority of  the  South  American  states,  and  even  some  in  Africa  have 
now  come  upon  a  gold  basis.  China  is  the  only  great  nation  with  a 
silver  standard. 

1487.  Because  the  gold  standard  is  of  general  acceptance  among 
commercial  nations,  and  output  and  total  supply  bid  fair  to  increase 
for  years,  there  has  arisen  and  spread  this  belief  that  the  value  of 
gold  will  continue  to  depreciate,  and  that  this  depreciation  will  be 
measured  by  the  rise  in  the  average  price  level.  Corollary  to  this 
is  the  thought  that  a  rising  price  level,  if  long  continued,  is  accom- 
panied by  rising  or  high  interest  rates.  High  interest  rates  mean,  of 
course,  low  prices  for  bonds. 

1488.  The  Quantity  Theory  of  Money.  At  the  bottom  of  this  con- 
tended relation  between  the  gold  supply  and  bond  prices  is  the  quan- 
titative or  quantity  theory  of  money.  Therefore  a  word  as  to  this 
theory.  Economically  speaking,  the  value  of  a  thing  is  what  it  will 
bring  in  exchange  for  some  other  thing.  The  thing  we  desire  less 
and  wish  to  dispose  of,  and  the  thing  we  desire  more,  and  wish  to 
obtain,  are  not  necessarily  material ;  either  or  both  may  be  in- 
tangible.   Goods  may  be  exchanged  for  money ;  labor,  for  good  will. 

1489.  The  exchange  of  thing  for  thing  is  barter.  Barter  is  a  social 
activity  of  all.  An  advance  in  commercial  intelligence  results  in  the 
use,  by  custom  and  law,  of  a  standard  or  standards  of  value,  for 
the  convenience  in  exchange  that  results.  This  standard  may  be 
wampum  or  skins,  for  instance.  Obviously,  if  the  supply  of  beads 
or  animals,  from  which  the  wampum  or  skins  are  obtained  and 
freely  made,  should  suddenly  be  increased  in  the  tribe  or  nation 
which  used  the  standards  mentioned,  it  would  take  more  wampum 
or  skins  to  buy  a  gun  or  horse,  than  theretofore. 

1490.  Barter  is  succeeded  by  regulated  business,  and  wampum  and 
skins  by  less  destructible  and  more  portable  and  denominational 
coin.  The  value  of  a  thing  then  becomes  thought  of  in  terms  of 
coin :  value  becomes  practically  synonymous  with  price.  Price, 
therefore,  is  the  ratio  of  coin  to  things.  The  more  things  and  the  less 
coin,  the  more  each  coin  will  buy.  The  less  things  and  the  more 
coin,  the  less  each  coin  will  buy.  This  is  the  basis  of  the  quantity 
theory  of  money.  It  is  a  logical  application  of  the  principle  of  sup- 
ply and  demand.  In  its  fundamentals,  as  expressed  here,  the  quan- 
tity theory  must  be  accepted.  They  who  protest  are  playing  with 
words.  The  theory  has  been  an  axiom  among  economists  for  a 
century  or  two. 


THE  FUTURE  OF  BOND  PRICES  497 

1491.  Although  coins  are  an  advance  over  skins,  they  themselves 
are  inconvenient  as  a  medium  of  exchange,  except  in  small  transac- 
tions. More  convenient  are  paper  certificates,  upon  presentation  of 
which  at  some  appointed  place  of  exchange  like  a  bank  or  a  treasury, 
the  holder  may  obtain  coin  in  the  quantity  specified.  For  larger 
transactions  still,  when  the  value  of  the  consideration  demands  se- 
curity in  the  passage  of  it,  non-negotiable  credit  instruments  have 
been  devised  to  take  the  place  of  coin  and  paper  certificates.  Further 
than  this,  for  one  reason  or  another  a  government  may  see  fit  to 
issue  fiat  money:  irredeemable  paper  that  may  legally  be  tendered 
in  payment  of  debts  in  which  the  contract  does  not  call  for  payment 
in  any  specified  form. 

1492.  The  value  of  a  thing,  then,  is  expressed,  not  in  terms  of 
coin,  but  of  money,  and  by  money  is  meant,  not  only  coin  and  coin 
certificates,  greenbacks  and  banknotes,  but  also  credit  currency — all 
to  the  extent  that  they  obtain  general  acceptance  as  money  and 
therefore  perform  the  functions  of  money. 

1493.  The  Equation  of  Price.  Expressed  in  a  mathematical  way, 
the  essential  principle  of  the  quantity  theory  is  that  since 

Supply 

Value  =^r 1 ,  therefore 

Demand 

Money 

Price  =yt^-. — 
Things 

1494.  But  since  not  all  things  are  for  sale,  and  some  money  never 
circulates,  and  the  amount  of  each  which  affects  price  is  the  amount 
that  business  brings  into  the  market, 

The  Demand  for  Money 

The  Supply  of  Money 
Price= 


The  Demand  for  Things 
The  Supply  of  Things 

1495.  In  a  sentence :  "  Price  is  the  equation  of  the  ratio  of  the 
supply  to  the  demand  of  goods"  (things)  "  on  the  one  hand,  and 
of  the  supply  to  the  demand  of  money  and  credit  on  the  other." 

1496.  It  is  customary  to  entitle  things  purchasable,  which  is  the 
denominator  of  this  equation,  "  commodities,"  but  the  term  is  mis- 


498  THE  FUTURE  OF  BOND  PRICES 

leading;  for  we  associate  commodities  more  particularly  with  the 
material  things  of  our  daily  life,  such  as  foods,  building  materials, 
supplies,  etc.  By  commodities  should  be  understood  anything  which 
is  bought  and  sold.  Labor  and  franchises  are  just  as  much  com- 
modities, in  our  sense,  as  wheat  and  steel, 

1497.  The  initial  letters  of  the  three  terms,  price,  money,  and 
commodities,  give  us  the  equation  in  the  form 

M 

p=cr 

but  it  needs  still  further  development. 

1498.  If  a  dollar  passes  from  one  hand  to  another  during  a  day, 
so  that,  in  all,  four  persons  have  made  purchases,  and  four  have 
made  sales,  with  it,  of  one  dollar  each  during  that  day,  then  it  has 
performed  the  work  of  any  four  dollars  which,  less  active,  have 
taken  one  day  to  pass  from  one  buyer  to  another.  To  all  intents  and 
purposes,  therefore,  the  volume  of  money  is  increased  according  to 
the  rapidity  with  which  it  circulates.  "  The  nimble  sixpence  does 
as  much  work  as  the  slow  shilling."  This  principle  is  called  the 
velocity  of  circulation.  Applied  most  broadly  it  involves  the  activity 
of  all  money  capital.  / 

1499.  Likewise,  if  a  bushel  of  wheat,  by  reason  of  a  perfected 
mechanism  of  exchange,  can  be  sold  at  one  dollar,  ten  times  during 
a  day.  it  will  require  ten  dollars  of  money  or  money  credits  to  finance 
it ;  whereas  if  sold  only  once,  only  one-tenth  of  this  amount  of  money 
would  be  involved  in  the  exchange.  Therefore  the  rate  of  turnover 
is  as  important  in  commodities  as  in  money.  The  amount  of  com- 
modities multiplied  by  the  rapidity  of  exchange  is  the  volume  of 
business. 

1500.  If  v  =  velocity  of  circulation 

and  r  =  rapidity  of  exchange 

Mv 

p=oF 

That  is  to  say,  the  price  of  commodities  is  determined  by  the  re- 
lation of  the  amount  of  activity  of  capital  to  the  volume  of  busi- 
ness. 

1501.  The  unstable  equilibrium  of  this  equation  is  liable  at  any 
time  to  be  upset  by  a  psychological  factor.  Price  is  not  merely  the 
mechanical  adjustment  of  demand  and  supply;  it  is  the  composite 


THE  FUTUEE  OF  BOND  PRICES  499 

judgment  of  buyers  and  sellers  as  to  future  adjustment  of  demand 
and  supply.  This  factor  has  its  most  apt  illustration  in  the  price 
movement  of  the  exchanges.  Failure  to  appreciate  its  value  is  the 
cause  of  much  puerile  criticism  of  the  exchanges. 

1502.  Gold  in  the  Price  Equation.  To  return  now  to  the  main 
quest, — by  a  study  of  commodity  prices,  we  are  seeking  to  establish 
a  relation  between  bond  prices  and  an  increasing  gold  production. 

1503.  The  first  thing  to  bear  in  mind  is  the  hopeless  inadequacy 
of  any  statistics  as  yet  compiled  or  likely  to  be  compiled  in  the  near 
future.  The  nearest  approach  to  reliable  figures  is  in  the  matter  of 
recent  gold  and  silver  production.  From  the  discovery  of  America 
until  1885,  we  are  dependent  upon  a  table  of  averages  for  certain 
periods  made  by  Dr.  Adolph  Soetbeer.  From  1885  to  the  present  we 
have  the  annual  estimates  of  the  Bureau  of  the  United  States  Mint. 
These  estimates  are  based  on  interrogatories  presented  in  the  name  of 
the  Government  by  our  consular  representatives  to  the  authorities  of 
the  countries  in  which  they  are  resident.  A  reading  of  their  reports 
is  prima  facie  evidence  that  the  estimates  of  the  Mint  only  approxi- 
mate the  facts.  From  some  countries,  for  instance,  it  has  not  been 
possible  to  obtain  the  net  coinage,  i.e.  less  domestic  and  foreign 
coinage  melted  for  reeoinage,  as  well  as  old  material,  plate,  etc., 
used  in  coinage.  In  1908  the  amount  of  this  reeoinage  in  the  26 
countries  reporting  was  $26,800,000  gold  and  $35,680,000  silver. 

1504.  As  we  shall  see  later,  we  are  as  much  concerned  with  the 
world's  total  stock  of  coined  gold  as  with  the  annual  product;  but 
conjectures  as  to  the  total  stock  in  1850,  let  us  say,  vary  by  100 
per  cent,  or  more.  This  is  because  there  were  no  satisfactory  records 
of  production  at  that  time,  or  previously,  and  there  are  now  no 
means  of  ascertaining  what  proportion  of  the  gold  then  existent 
was  used  in  the  arts,  or  what  proportion  has  since  been  lost  to  cur- 
rency by  abrasion,  shipwreck,  hoarding,  etc. 

1505.  But,  accepting  these  inaccuracies  as  negligible,  our  first 
contention  is  that  although  an  increase  in  the  annual  gold  supply 
seems  inevitable  for  some  time  to  come,  according  to  the  quantity 
theory  this  is  not  the  issue;  our  chief  concern  is  with  the  total  money 
supply  in  its  relation  to  the  volume  of  business.  Is  it  inevitable  that 
gold  and  silver  and  their  certificates,  and  greenbacks  and  banknotes, 
and  minor  coins  and  credit  instruments,  which  constitute  the  M  of 
the  price  formula,  will  continue  to  increase  in  volume?  Or  if  an 
increase  is  inevitable  will  the  M  increase  as  rapidly  as  gold  coinage 
or  the  volume  of  business? 


500  THE  FUTURE  OF  BOND  PRICES 

1506.  If  our  chief  fear  is  from  gold,  let  us  see  what  part  of  the 
world's  gold  is  coined.  In  1008,  20  per  cent,  of  the  estimated  total 
output  was  used  in  the  arts,  etc.,  but  the  average  of  a  period  of 
years  is  more  accurate.  Since  1879  the  United  States  Government 
has  furnished  for  use  in  manufactures  and  the  arts,  $450,000,000 
of  new  gold.  About  $50,000,000  of  I  his  was  foreign  coin  and  bullion, 
but  offsetting  this  is  the  fact  that  the  Government  is  not  the  sole 
purveyor  to  industry.  During  the  same  period  the  output  of  gold 
in  the  United  States  was  about  $1,500,000,000.  In  other  words, 
if  the  United  States  is  a  criterion,  30  per  cent,  of  gold  from  the 
mines  goes  into  arts  and  manufactures.  Allowing  10  per  cent,  for 
loss,  the  Depredationists  are  usually  ready  to  concede  that  not  more 
than  GO  per  cent,  of  new  gold  is  coined.  And  yet  they  cite  statistics 
of  total  production  rather  than  those  of  total  coinage.  Some  of 
them  even  will  concede,  "  It  is  certain  that  about  half  of  the  gold 
produced  ....  was  used  in  the  arts  or  lost." 

1507.  Secondly,  What  part  of  the  world's  metallic  money  is  gold? 
Since  1872  the  mints  of  the  world  have  coined  $8,011,467,123  of  gold 
and  $5,177,695,596  of  silver  (coining  value).  That  is,  about  60  per 
cent,  has  been  gold  and  40  per  cent,  silver.  But  the  demonetization 
of  silver  since  1872  vitiates  this  average.  The  average  for  1906, 
1907,  1908  was  about  66  per  cent,  gold  and  34  per  cent,  silver. 

1508.  Since  metallic  money  in  its  entirety,  and  not  solely  gold,  is 
part  of  the  M  of  the  price  formula,  it  is  almost,  if  not  quite,  as 
necessary  to  consider  the  coinage  value  of  silver  as  of  gold.  This  the 
Depreciationists  usually  fail  to  do. 

1509.  The  following  tables  will  illustrate  how  differently  we  shall 
look  upon  M  of  the  formula,  if  we  think  of  it  as  at  least  gold  and 
silver,  rather  than  as  merely  gold: 

World  Production  of  Gold  and  Silver  (in  ounces) 


Gold 

Increase 

Silver 

Increas 

1891 

6,320,194 

137,170,919 

1896 

9,783,000 

55£ 

157,061,000 

15# 

1901 

12,625,527 

29# 

173,011,238 

100 

1908 

21,378,481 

69# 

203,186,370 

12# 

1510.  But  with  silver  demonetized,  a  comparison  of  the  rates  of 
increase  in  the  two  metals  should  deal,  not  with  weights,  but  with 
coinage  values. 


THE  FUTURE  OF  BOND  PRICES  501 

Coinage  of  Gold  and  Silver  in  the  Mints  of  the  World 


Gold 

Increase 

Silver 

Increase 

Gold  and 
Silver  Increase 

1891 

119,534,122 

138,294,367 

1896 

195,899,517 

640 

159,540,027 

150 

310 

1901 

248,093,787 

270 

138,911,891 

120  x 

90 

1908 

327,018,200 

320 

194,692,737 

400 

310 

1511.  Briefly,  although  the  coinage  value  of  gold  in  the  year  1908 
was  174  per  cent,  more  than  in  1891,  the  coinage  value  of  gold  and 
silver  together  was  only  102  per  cent,  greater.  The  fact  that  this 
coinage  was  not  all  new  metal  will  not  militate  against  results,  since 
the  recoinage  factors  will  probably  cancel  out. 

1512.  Thirdly,  what  part  of  the  world's  "  money  proper  "  stock 
of  all  kinds  is  gold?  The  dearth  of  data  is  disheartening.  The 
Director  of  the  Mint  has  published  a  table  of  the  stocks  of  money 
in  1873  of  13  leading  countries,  dividing  the  stock  into  gold,  silver, 
and  uncovered  paper.  Gold  (coin  and  bullion)  was  slightly  over 
25  per  cent,  of  the  total,  and  paper  slightly  more  than  50  per  cent. 

1513.  A  similar  table  from  the  Mint  Report  of  1896,  embracing 
34  countries,  credits  gold  with  over  46  per  cent,  of  the  entire  mone- 
tary stock,  and  uncovered  paper  with  less  than  29  per  cent.;  and 
this  table,  although  "  necessarily  an  estimate,"  was  "  believed  to 
exhibit  approximately  the  stock  of  money  in  the  world."  The  change 
in  the  ratio  of  gold  to  the  total  stock  was  undoubtedly  due  to  the 
demonetization  of  silver.  For  the  future  this  influence  is  not  likely 
to  work  much  further  change. 

1514.  For  the  fiscal  year  1908-09  the  gold  coin  and  bullion  in 
the  United  States  were  48  per  cent,  of  all  moneys.  Government  and 
national  banknotes  were  31  per  cent.  Perhaps,  then,  gold  forms 
nearly  one-half  of  the  world's  present  metallic  and  paper  money 
stock. 

1515.  Fourthly,  what  relation  of  volume  does  gold  bear  to  the 
world's  credit  currency?  The  writer  believes  that  there  are  extant 
no  trustworthy  figures  for  the  world  at  large.  So  far  as  those  of 
the  United  States  may  be  useful  for  analogy  they  are  as  follows : 

1516.  In  1909  the  estimated  total  individual  deposits  available 
for  transfer  by  check  in  national,  state,  savings,  and  private  banks, 
and  loan  and  trust  companies  were  $14,035,000,000,  and  the  total 

1  Decrease. 


502  THE  FUTURE  OF  BOND  PRICES 

estimated    stock   of   gold    coin    and    bullion    in    the   country   was 
$1,041,000,000,  or  about  12  per  cent. 

1517.  Quantitatively  speaking,  then,  these  appear  to  be  the  facts 
concerning  the  relation  of  gold  to  M  of  the  price  formula : 

1.  From  50  to  GO  per  cent,  of  all  new  gold  is  converted  into 
money. 

2.  About  65  per  cent,  of  metallic  money  value  is  gold. 

3.  The  comparatively  slow  increase  in  the  coinage  value  of  silver 
retards  the  increase  in  the  total  stock,  so  that  instead  of  fearing 
the  increase  of  gold,  amounting  to  174  per  cent,  in  17  years,  we  have 
only  to  reckon  with  the  metallic  increase  of  102  per  cent,  for  com- 
parison with  the  probable  increase  in  the  volume  of  business. 

4.  Perhaps  45  or  50  per  cent,  of  all  "  money  proper  "  is  gold. 

5.  But  infinitely  more  important  than  all  the  foregoing,  gold  is 
only  a  fraction  of  the  world's  total  currency, — only  12  per  cent,  of 
the  credit  currency  in  this  country, — and  therefore  subject  in  its 
purchasing  power  to  the  limits  that  law  or  expediency  places  upon 
the  inflation  of  currency. 

1518.  We  have  dealt  thus  far  wholly  with  gold  in  its  relation  to 
money,  and  have  emphasized  the  fact  that  gold  is  but  a  part  of 
money,  and  that  the  much-talked-of  increase  in  the  gold  stock  has 
less  mathematical  bearing  than  most  people  believe.  Nevertheless, 
since  gold  is  the  basis  of  ultimate  redemption  of  most  redeemable 
money,  and  has  an  intimate  relation  to  the  worth  of  fiat  money, 
the  demand  and  supply  of  gold  largely  influence  the  demand  and 
supply  of  other  kinds  of  money, — more  strongly  than  is  indicated 
by  the  quantitative  ratio. 

1519.  The  development  of  banking  also  is  contributing  to  the 
disproportionate  influence  of  the  monetary  standard.  Within  a 
country,  clearing  house  systems  reduce  exchanges  of  credit  to  mere 
settlement  of  daily  balances;  and  between  countries,  international 
banking  houses  are  constantly  reducing  the  volume  of  gold  ship- 
ments necessary  to  the  adjustment  of  foreign  accounts.  The 
greater  the  facilities  for  credit  exchange,  the  greater  the  tendency 
toward  superfluity  of  gold. 

1520.  This  has  been  the  conclusion  of  economists  who  have 
studied  the  effects  of  the  discovery  of  gold  in  California  and  Aus- 
tralia. These  effects  had  a  profounder  influence  in  countries  that 
had  developed  banking  and  credit  facilities.  There,  new  gold,  con- 
verted into  banking  reserves,  and  made  the  basis  of  banking  credit, 


THE  FUTURE  OF  BOND  PRICES  503 

increased  the  demand  for  purchasables,  and  therefore  the  price  of 
them. 

1521.  Velocity  of  Circulation.  As  to  velocity  of  circulation,  which 
expresses  the  dynamic  efficiency  of  money,  Prof.  Irving  Fisher 
writes : 

"An  inviting  field  for  statistical  study  is  offered  by  the  velocity  of  circulation. 
Pierre  d'Essars  has  shown  that  the  rate  of  turn-overs  of  bank  deposits  varies  enor- 
mously in  Europe  ;  for  instance,  from  160  times  a  year  in  the  Reichsbank  of  Germany 
to  less  than  once  a  year  in  the  Bunk  of  Greece.  Similar  variations  have  been  found 
by  the  present  writer  in  this  country.  The  velocity  of  circulation  for  money  proper 
has  never  been  properly  computed.  Judging  from  the  rate  of  turn-over  among  Yale 
students,  it  would  be  something  like  once  a  week." 

1522.  If  the  multiples  of  M  in  the  price  equation  are  such  a  hope- 
lessly unknown  quantity,  why  should  we  be  grievously  troubled  at 
an  increase  in  that  part  of  M  which  stands  for  gold  and  gold's 
representatives  ? 

1523.  Commodities  in  the  Price  Equation.  If  the  constituency, 
volume,  and  activity  of  money — the  numerator — perplex  us,  what 
shall  we  say  of  commodities  and  their  rapidity  of  exchange, — the 
denominator? 

1524.  What  is  meant  by  commodities  has  been  stated.  All  things 
tangible  or  intangible,  except  money,  that  are  exchanged  for  money 
or  credit,  are  commodities  within  the  meaning  of  the  equation. 
There  are  not,  and  never  can  be,  estimates  of  the  volume  of  com- 
modity units  as  trustworthy  as  the  estimates  of  money  volume. 
We  may  have  some  slight  apprehension  of  the  stock  of  material 
things  in  the  world,  and  of  the  yearly  increment  to  that  stock  as 
expressed  for  instance  (in  a  previous  chapter)  by  the  annual  crop 
and  mineral  production  in  the  United  States, — bales  of  cotton 
and  tons  of  metal.  We  may  have  better  knowledge  of  the  commodity 
real  property,  and  we  may  deal  intelligently  with  its  units.  But 
what  of  business  options,  good-will,  municipal  and  state  franchises 
and  the  like?  How  shall  they  be  estimated  and  measured,  their 
volume  computed  and  reduced  to  a  unit  in  common  with  other 
commodities? 

1525.  The  Rapidity  of  Commodity  Exchange.  However  immeasur- 
able and  irreducible,  it  is  as  certain  that  the  units  of  commodities 
are  constantly  increasing  in  number,  as  it  is  the  units  of  money 
are.  To  deny  it  would  be  to  deny  the  industrial  progress  of  the 
world.  The  question  then  is,  are  they  increasing  as  rapidly,  and 
if  so,  is  the  velocity  of  commodity  exchange  increasing  as  rapidly  as 


504  THE  FUTURE  OF  BOND  PRICES 

thai  of  money  circulation?    If  any  one  has  a  convincing  answer  to 
either  question  he  lias  Tailed  as  yet  to  put  it  into  print. 

1526.  The  quantity  of  0  in  the  equation  is  unknowahle.  The  aver- 
age rapidity  of  exchange  r  is  unknown.  Indeed,  in  our  thinking  it  is 
hard  to  separate  the  v  of  the  numerator  from  the  r  of  the  denomi- 
nator; the  rate  of  velocity  circulation  from  the  rapidity  of  com- 
modity exchange,  for  the  major  part  of  commodity  exchange  is 
achieved  through  the  medium  of  credit,  and  therefore  measured,  to 
a  degree,  by  bank  dealings  and  international  exchange.  Further- 
more an  acceleration  in  money  and  credit  circulation  is  at  one  time 
caused  by,  and  at  another  time  the  cause  of,  acceleration  in  com- 
modity exchange. 

1527.  But,  although  an  increase  or  decrease  of  v  naturally  im- 
plies some  corresponding  increase  or  decrease  of  r,  these  two  factors 
in  the  fraction  do  not  cancel  out;  each  must  be  considered  sepa- 
rately in  relation  to  its  multiplicand,  M,  and  C,  respectively. 

1523.  Since,  therefore,  it  is  impossible  to  prove  statistically,  that 
the  increase  in  rate  of  gold  production  exceeds  the  world's  present 
requirements  (which  are  expressed  in  CE),  the  Depredationists  are 
obliged  to  content  themselves  with  the  categorical  statement  that 
such  is  the  case,  and  in  confirmation  to  point  to  the  fact  that  in 
recent  years  prices  have  risen. 

1529.  In  America,  at  least,  the  argument  has  taken  this  form: 

1.  "  That  both  the  output  and  supply  of  gold  are  likely  to  in- 
crease rapidly  for  many  years. 

2.  That,  therefore,  the  value  of  gold  will  depreciate  as  the  quan- 
tity increases. 

3.  That  this  depreciation  will  be  measured  by  the  rise  in  the 
average  price  level. 

4.  That  a  rising  price  level,  if  long  continued,  is  accompanied  by 
rising  or  high  interest  rates. 

5.  That  high  interest  rates  mean  low  prices  for  bonds  and  all 
other  long  time  obligations  drawing  fixed  rates  of  interest,  divi- 
dends, or  income."  1 

1530.  We  have  devoted  what  may  seem  disproportionate  space 
to  the  quantity  theory  in  order  to  make  perfectly  clear  the  fact 
that  the  second  and  third  statements  do  not  necessarily  follow  from 
the  first.  The  gold  supply  may  increase  rapidly,  and  yet  the  value 
of  a  unit  of  gold  may  not  depreciate  because  political  or  other 
events  may  palsy  trade  and  lessen  the  velocity  of  circulation,  and 

1  The  Gold  Supply  and  Prosperity.    New  York,  1907,  p.  193. 


THE  FUTURE  OF  BOND  PRICES  505 

in  this  way  lessen  the  efficiency  of  money,  without  lessening  in  full 
correspondence  the  rapidity  of  commodity  exchange. 

1531.  Or  on  the  other  hand  the  gold  supply  may  increase  and  the 
velocity  of  circulation  also,  but  the  supply  of  commodities  may  in- 
crease in  greater  ratio,  and  in  a  period  of  active  speculation  the 
rapidity  of  exchange  also. 

1532.  These  or  similar  conditions  in  the  United  States  must  have 
counterbalanced  the  tendency  of  gold  to  depreciate,  from  1891  to 
1897,  for  during  that  period  our  annual  gold  production  increased 
from  1,G04,000  ounces  to  2,774,000  ounces,  the  world's  production 
from  6,320,000  ounces  to  11,420,000  ounces,  but  Dun's  index  num- 
ber for  commodities  fell  from  98.723  to  75.187. 

Surely  an  economic  factor  on  which  we  can  base  our  business 
dealings  ought  to  make  its  influence  felt  before  the  lapse  of  six 
vears ! 

1533.  The  Distribution  of  Money  and  Commodities.  The  principal 
fallacy  in  this  gold  depreciation  theory  lies  in  a  failure  to  recognize 
the  proper  application  of  the  quantity  theory  to  the  price  problem. 

Mr.  Bronson  C.  Keeler  has  stated  as  clearly  as  any  one  how  the 
quantity  theory  should  be  modified  to  meet  conditions  affecting 
prices. 

"Each  country  in  the  world  receives  its  distributive  share  of  an  international 
standard  of  value,  and  that  share  constitutes  the  measure  of  value  of  the  property 
offering  for  exchange  in  that  country.  Each  community  receives  its  share  of  the 
country's  share,  and  each  man  in  the  community  receives  his  distributive  share  of 
the  community's  share. 

"  These  distributive  shares  are  divided  into  commodity- funds,  a  certain  percentage 
of  the  total  being  used  as  the  measure  of  the  several  commodities  exchanged.  Thus, 
in  an  average  community,  about  15  per  cent,  of  the  money  goes  for  rent,  and  consti- 
tutes the  rent  fund  ;  about  45  per  cent,  for  food,  .  .  .  and  so  on.  These  commodity- 
funds  vary  from  season  to  season  and  from  minute  to  minute 

"In  general,  at  any  time,  at  any  given  point,  the  price  at  which  a  commodity  sells 
is  determined  by  the  amount  of  money  in  that  commodity-fund  divided  by  the  quan- 
tity of  that  commodity  offered  for  sale.  The  division  is  performed  by  the  interplay 
of  demand  and  supply;  by  what  Adam  Smith  called  'the  higgling  of  the  market.* 

"  A  moment's  reflection  will  satisfy  any  practical  man  that  these  commodity-funds 
are  real  entities,  and  not  theoretical.  Every  Congress  or  legislature,  in  passing  an 
appropriation  bill,  recognizes  their  existence;  ....  A  second  reflection  will 
convince  a  man  that  while  these  commodity-funds  differ  from  time  to  time,  and 
under  varying  circumstances,  they  yet  bear  a  certain  fixed  ratio  to  one  another.  .  .  . 
And  a  third  reflection  will  convince  him  that  each  commodity-fund  in  a  community 
bears  a  ratio  more  or  less  fixed  to  that  community's  distributive  share  of  money. 
Statistics  also  confirm  this  abundantly.  If  the  value  of  money  changes  either  way, 
relatively  to  the  volume  of  commodities,  the  percentages  will  remain  the  same,  and 
therefore  prices  must  change  correspondingly,  otherwise  the  money  would  not  be  in 
the  community's  distributive  share."  * 

Ubid.,  pp.  24-26. 


506  THE  FUTURE  OF  BOND  PRICES 

1534.  The  application  to  our  study,  of  this  theory  of  the  dis- 
tribution of  money  and  commodities,  is  that  we  must  compare 
statistics  of  gold  production  and  prices  which  relate  to  the  same 
political  divisions,  and  if  possible  to  the  same  general  classes  of 
commodity-funds. 

1535.  A  comparison  of  the  world's  total  supply  of  money,  and 
its  average  velocity  of  circulation,  with  the  average  level  of  world's 
commodity  prices  would  be  valid;  but  this  is  impossible  for  we 
haven't  the  figures  for  commodities.  The  Aldrich  Senate -Report 
stopping  at  1891,  the  tables  of  the  Bureau  of  Economic  Research, 
covering  1889-1900,  the  Reports  of  the  United  States  Bureau  of 
Labor,  Dun's  and  Bradstreet's  Indexes 1  are  reasonably  compre- 
hensive within  their  own  field  of  inquiry,  viz.,  material  commodities 
within  the  United  States;  but  in  no  other  country  have  we,  probably, 
equally  good  authority.  In  England  Jevons'  and  Sauerbeck's  tables 
cover  the  last  25  years,  but  they,  and  the  tables  of  the  London 
Economist,  are  not  sufficiently  comprehensive.  Besides  the  fore 
going  we  have  the  indexes  of  Soetbeer  and  Heinz  in  Germany,  and 
for  Japan,  India,  and  China,  the  Japanese  Report.  A  few  other 
less  well-known  tables  and  reports  might  be  mentioned.  The  entire 
material,  however,  is  utterly  inadequate  for  detailed  conclusions. 

1536.  It  would  be  more  nearly  valid  to  make  a  comparison,  over 
a  period  of  years,  of  the  average  volume  of  money  and  credit  of  all 
kinds,  in  the  United  States,  and  the  average  rate  of  circulation, 
with  the  average  price,  of  all  material  commodities,  in  the  United 
States,  but  all  students  of  the  subject,  thus  far,  have  lacked  either 
the  courage  or  the  capacity.  Moreover  the  results  would  have  to 
be  checked  in  some  way  by  the  "  distributive  shares  "  and  the  "  com- 
modity-funds "  of  the  rest  of  the  world. 

1537.  The  comparison  that  commonly  has  been  made  is,  we  be- 
lieve, absolutely  invalid  beyond  the  most  vague  generalizations, 
although  we  ourselves  have  used  it  against  the  users  some  para- 
graphs above.  It  is  the  comparison  of  the  increase  in  the  world's 
supply  of  gold  with  the  recent  increase  in  commodity  prices  within 
the  United  States. 

1538.  Local  Causes  for  the  Increase  in  Commodity  Prices.  Because 
commodity  prices  in  the  United  States  have  risen  markedly,  how- 
ever, since  1897,  it  is  natural  and  proper  to  attribute  a  part  of  the 

1  Bradstreet's  Index,  for  instance,  is  now  built  on  the  basic  prices  for  the  standard 
grades  of  96  commodities  in  the  principal  wholesale  markets. 


THE  FUTURE  OF  BOND  PRICES  507 

vise  to  the  increase  of  gold.  There  has  been  a  much  less  marked 
rise  in  Germany  and  France,  and  none  of  any  consequence  in  Eng- 
land, if  we  are  to  credit  the  imperfect  foreign  indexes.  Then  let 
as  see  whether  the  chief  causes  are  not  probably  local,  and  subject 
to  change  under  future  commercial  and  political  evolution. 

1539.  The  March,  1909,  Bulletin  of  the  United  States  Bureau  of 
Labor  gives  a  very  detailed  and  careful  analysis  of  the  movements 
of  commodity  prices  in  the  United  States  for  recent  years.  Referring 
to  influences  affecting  prices  the  Bulletin  says : x 

"  The  causes  are  too  complex,  the  relative  influence  of  each  too  uncertain, in  some 
cases  involving  too  many  economic  questions,  to  permit  their  discussion  in  connec- 
tion with  the  present  article.  It  will  be  sufficient  to  enumerate  some  of  the  influences 
that  cause  changes  in  prices.  Such  influences  include  variations  in  harvest,  which 
not  only  contract  or  expand  the  supply  and  consequently  tend  to  increase  or  decrease 
the  price  of  a  commodity,  but  also  decrease  or  increase,  to  a  greater  or  a  less  degree, 
the  purchasing  power  of  such  commodities  as  are  dependent  in  whole  or  in  part 
upon  such  commodity;  changes  in  demand  due  to  changes  in  fashions,  season,  etc. ; 
legislation  altering  internal  revenue  taxes,  import  duties,  or  bounties;  inspection  as 
to  purity,  or  adulteration;  use  of  other  articles  as  substitutes— as,  for  instance,  an 
advance  in  the  price  of  beef  will  cause  an  increased  consumption  of  pork  and  mut- 
ton; improvements  in  methods  of  production  which  will  tend  to  give  either  a  better 
article  for  the  same  price  or  an  equal  article  for  a  lower  price;  cheapening  of  trans- 
portation or  handling;  speculative  manipulation  of  the  supply  or  of  the  raw  product; 
commercial  panic  or  depression;  expanding  or  contracting  credit;  overproduction; 
unusual  demand  owing  to  steady  employment  of  consumers;  short  supply  owing  to 
disputes  between  labor  and  capital  in  industries  of  limited  producing  capacity;  as  in 
the  anthracite  coal  industry  in  1902;  organization  or  combination  of  mills  or  produc- 
ers, thus  enabling,  on  the  one  hind,  a  greater  or  less  control  of  prices  or,  on  the  other 
hand,  economies  in  production  or  in  transportation  charges  through  the  ability  to  sup- 
ply the  article  from  the  point  of  production  or  manufacture  nearest  the  purchaser. 
So  far  as  individual  commodities  are  concerned,  no  conclusion  can  safely  be  formed 
as  to  causes  without  the  examination  of  the  possible  influence  of  several — in  some 
cases,  perhaps  all — of  the  causes." 

1540.  Although  the  Bulletin  makes  no  effort  to  explain  a  general 
change  in  price  level,  it  does  recognize  two  phases  of  the  applica- 
tion of  the  quantity  theory  which  are  usually  overlooked.  It  sees 
that  price  variations  originate  in  commodity  production  as  well  as 
in  gold  production.  It  sees  that  community  and  class  distribution 
of  money  and  commodities  are  important,  as  well  as  the  general 
money^  and  commodity  volume.  By  implication  it  suggests  that  such 
things  as  the  tariff,  currency  inflation,  the  formation  of  trusts, 
monopolies,  and  labor  unions,  and  governmental  and  personal  ex- 

JPp.  216-217. 


508  THE  FUTURE  OF  BOND  PRICES 

travagance  are  country-wide  influences  tending  to  raise  the  prices 
of  our  "  distributive  share "  of  the  world's  commodities,  out  of 
proportion  to  any  general  rise  throughout  the  world,  if  there  is 
such  a  rise. 

For  obvious  reasons  the  Bulletin  lays  no  emphasis  on  the  tariff. 
Shortly  before  his  election  Governor  Woodrow  Wilson  of  New 
Jersey  said: 

"  Now  what  is  the  cause  of  the  high  cost  of  living?  The  cause  is 
that  the  tariff  wall  has  been  built  so  high  that  business  concerns, 
being  absolutely  free  from  the  danger  of  foreign  competition,  can 
get  together  and  control  prices  and  cost." 

1541.  But  the  Bulletin  also  mentions  a  fact  which  is  generally 
recognized,  but  which  has  not  as  yet  been  mentioned  in  these  pages; 
that  constantly  lessening  costs  of  manufacture  and  distribution 
tend  to  lessen,  or  retard  the  increase  in  prices  in  general.  It  has 
been  estimated  that  this  force  has  a  tendency  to  lower  prices  about 
2£  per  cent,  a  year. 

1542.  Influences  Tending  Toward  Lower  Prices.  This  leads  us  to 
say  that  a  little  thought  devoted  to  the  influences  mentioned  in  the 
Bulletin  will  satisfy  most  people  that,  not  only  has  the  rise  in 
prices  (most  marked  in  the  United  States)  been  due  to  many  causes, 
of  which  gold  is  only  one,  but  that  many  of  these  causes,  in  their 
strength  peculiar  to  the  United  States,  are  as  likely  to  work  toward 
a  downward  movement,  in  the  future,  as  towTard  an  upwrard. 

These  depressants  may  be  classed  as  the  causes  which  tend  to 
decrease  the  amount  or  circulation  of  money,  and  those  which  tend 
to  increase  the  amount  or  circulation  of  commodities. 

1543.  Influences  Tending  Toward  Gold  Absorption.  Chief  among 
the  former  is  the  growing  dissatisfaction  with  the  currency  situation 
in  this  country  and  abroad.  The  Federal  Government  estimates 
that  on  January  1,  1907,  there  was  $4,132,000,000  uncovered  paper 
in  circulation  throughout  the  world.  Speaking  of  this  matter  Mr. 
Maurice  L.  Muhleman,  ex-Deputy  Assistant  Treasurer  of  the  United 
States,  writes : 1 

"  It  is  well  known  that  in  estimating  the  uncovered  paper  volume,  the  specie  in 
hank  is  all  used  to  offset  note  liabilities,  leaving  nothing  against  deposit  or  other 
credit  liabilities;  and  a  substantial  part  of  the  covering  specie  consists  of  silver. 
Here,  then,  is  a  broad  field  for  the  employment  of  the  increasing  gold  product,  suf- 
ficient to  absorb  the  available  product  for  a  decade  or  more,  which  governments 
should  recognize." 

1  The  Oold  Supply  and  Prosperity,  pp.  88-89. 


THE  FUTURE  OF  BOND  PRICES  509 

1544.  The  solution  in  this  country  of  an  inelastic  and  depreciated 
currency  may  be  the  maintenance  of  a  multiple  standard  of  value 
by  which  the  commodity  price  level  will  be  fixed.  The  price  level 
may  be  maintained  by  regulating  the  volume  of  money  in  circula- 
tion according  to  the  prescripts  of  a  monetary  commission  rather 
than  according  to  the  orders  of  the  Secretary  of  the  Treasury,  which 
are  emergency  measures,  affected  by,  and  liable  to,  hostile  criticism. 

1545.  We  shall  have  an  important  additional  use  for  the  precious 
metal  when  the  time  comes  that  our  banknote  circulation  is  based 
on  gold  rather  than  on  bonds. 

1546.  The  extension  of  the  gold  standard  to  those  countries  which 
have  not  yet  adopted  it,  will  tend  to  relieve  any  plethora  of  gold, 
but  only  to  the  extent  that  the  coinage  value  of  silver,  and  that  of 
any  paper  currency  which  may  be  built  upon  it,  are  reduced  thereby. 

1547.  In  general  it  may  be  said  that  the  present  trend  of  public 
opinion  is  toward  a  sounder  currency,  which  is  another  way  of 
stating  that  we  recognize  velocity  and  inelasticity  of  circulation 
to  be  the  chief  mechanical  causes  of  panics.  The  remedy  implies  a 
greater  amount  of  gold  held  in  reserve  against  each  commodity 
unit. 

1548.  Not  only  will  the  monetary  aspect  of  the  price  equation  be 
relieved,  in  all  probability,  by  enlarged  channels  for  the  diffusion 
of  gold  in  this  country,  but  there  is  a  natural  and  inevitable  check 
upon  gold  production  throughout  the  world.  An  oversupply  of 
gold  means  a  depreciation  of  its  value  in  terms  of  commodities 
until  the  point  is  reached  that  gold  mining  becomes  unprofitable. 
This  check  would  become  operative  long  before  the  world  could  up- 
heave in  economic  resolution,  but  would  become  decisive  hardly  be- 
fore a  period  of  rising  prices  sufficiently  long  and  uninterrupted  to 
raise  still  further  the  level  of  interest  rates. 

1549.  Influences  Tending  Toward  Increase  in  Commodities.  It  goes 
without  saying  that  the  volume  of  commodities  produced  will  de- 
pend upon  the  available  stock  and  the  demand.  Apart  from  in- 
creased demand  caused  by  mere  increased  money  and  credit,  the 
cheapened  cost  of  production  and  distribution,  of  which  we  spoke 
above,  means  that  more  goods  can  be  produced  for  the  same  money. 
The  United  States  is  fully  as  progressive  in  economies  of  production 
as  any  nation,  and  is  increasing  its  store  and  output  of  wealth 
accordingly. 

1550.  Even  in  the  satisfaction  of  normal  wants,  the  world's  de- 
mand has  tended  constantly  to  exceed  the  supply,  because  of  a. 


510  THE  FUTURE  OF  BOND  PRICES 

constantly  increasing  population.  This  is  particularly  true  in  the 
United  States,  in  which  immigration  augments  the  natural  in- 
crease. Furthermore,  the  spirit  of  extravagance,  "the  natural 
vice,*'  h;is  created  in  this  country  abnormal  demands  which  could 
not  be  satisfied  with  our  own  distributive  commodity  share,  and 
had  to  be  met  by  bidding,  at  abnormally  high  prices,  for  which 
the  tariff  is  responsible,  for  a  part  of  the  shares  of  foreign  nations. 
Checks  upon  freedom  of  immigration,  and  an  awakening  national 
realization  of  our  extravagance,  will  not  retard  the  increase  in 
commodity  production  so  much  as  it  will  direct  the  energies  of 
production  into  less  wasteful  channels,  thereby  increasing  the  less 
destructible  slock.  The  annual  output  of  purchasables  might  be 
lessened  for  a  time,  but  the  available  stock  would  be  enlarged. 

1551.  We  have  every  reason  to  believe  the  discovery  and  de- 
velopment of  new  resources  will  keep  pace  with  gold.  Mr.  Frank 
A.  Vanderlip  expressed  this  view  in  an  address  before  the  American 
Bankers'  Association  in  1905.    He  said : 

"  I  do  not  believe  the  gold  production  is  likely  to  become  a  serious  menace.  .  .  . 
What  I  do  believe  is  that  there  is  likely  to  follow  just  what  followed  in  the  two  former 
periods  of  the  world's  history  when  there  was  an  extraordinary  production  of  gold 
added  to  the  monetary  stocks.  One  of  these  periods  followed  the  discovery  of 
America,  when  the  treasures  of  Mexico  and  Peru  were  exploited.  The  other  was  in 
the  days  following  the  discovery  of  gold  in  California  and  Australia.  In  each  case  a 
mighty  impulse  was  ^iven  to  the  exploitation  of  virgin  fields  of  development.  It  seems 
to  me  not  improbable-  that  the  next  few  years  will  witness  the  expansion  of  the  field 
of  commercial  enterprise  into  new  places.  Countries  that  are  commercially  and 
industrially  backward  will  yield  to  this  new  influence.  It  seems  to  me  that  one  of 
the  direct  and  important  effects  of  this  great  production  of  gold  will  be  to  give  an 
impulse  to  the  development  and  industrial  exploitation  of  South  America,  Africa, 
Asia,  and  Eastern  Europe.  At  our  own  hand  is  South  America  on  one  side,  and 
China  and  Japan  on  the  other.  We  are  rapidly  awakening  to  the  commercial  possi- 
bilities within  these  countries.  If  we  are  to  have  an  influx  of  gold  more  than  ample 
to  sustain  the  credit  operations  for  our  own  domestic  atfairs,  that  fact  will  tend  to 
lead  our  interests  into  these  new  fields  of  exploitation.  Then,  in  turn,  a  wider  use  of 
credit  which  these  new  fields  will  develop  and  the  increased  reserves  which  that 
wider  use  of  credit  will  make  necessary,  will  probably  absorb  the  increasing  gold 
stock  into  beneficent  uses,  preventing  it  from  ever  becoming  a  serious  menace  to 
business  organization." 

1552.  The  Wall  Street  J  owned  says: 

"  In  the  United  States  alone  the  water  power  is  estimated  at  21,000,000  horse  power, 
of  which  only  a  fraction  has  yet  been  utilized.  To  harness  that  power  and  develop 
collateral  resources  might  easily  absorb  all  of  that  fearsome  gold  production  we  can 
well  lay  hands  on  for  the  next  20  years.  By  that  time  other  uses  will  be  found  for 
the  precious  product.  There  would  appear  to  be  no  immediate  occasion  for  alarm  over 
the  prospect  of  being  obliged  to  pay  10  pounds  in  gold  for  five  pounds  of  potatoes." 

1553.  Conclusion  as  to  the  Future  of  Commodity  Prices.     In  conclu- 
sion, it  is  the  writer's  belief,  after  a  study  of  prices,  that  the  amount 


THE  FUTURE  OF  BOND  PRICES  511 

of  careful  thought  and  statistical  research  that  has  been  devoted  to 
the  subject  is  not  sufficient  to  warrant  conclusion  either  that  an 
increased  supply  of  gold  has  been,  during  recent  years,  the  chief 
cause  of  higher  prices  in  certain  quarters  of  the  globe,  or  that  it 
will  be  the  chief  cause  of  possible  still  higher  prices  in  years  to  come. 

1554.  Many  will  undoubtedly  be  surprised  to  see  by  the  chart 
XIX  that,  although  the  tendency  of  commodity  prices  in  the 
United  States  has  been  upwards  for  the  past  14  years,  there  was  as 
pronounced  tendency  downwards  for  the  preceding  14  years,  and 
present  prices  are  but  slightly  above  the  average  for  the  past  50 
years.1  There  is  nothing  alarming,  then,  or  epoch-making,  in  the 
present  price  level,  or  in  the  present  so-called  high  cost  of  living. 

1555.  In  view  of  the  fact  that  it  is  material  commodities  of  the 
sort  most  affected  by  congestion  of  population  which,  in  the  main, 
are  the  basis  of  price  indexes,  it  is  very  significant  that  in  1860 
(which  begins  the  chart  of  commodity  quotations)  prices  were 
much  higher  than  at  present,  and  yet  the  per  capita  circulation  was 
only  $13.85,  whereas  now  it  is  $35.01, — and  this  in  spite  of  the 
greater  extension  of  credit  made  possible  to  each  unit  of  money  by 
increased  facilities  for  its  circulation,  and  by  the  increased  adapta- 
bility of  credit  instruments.  If  the  mere  quantity  $13.85  a  man 
meant  too  much  money,  wThat  of  $35.01? 

1556.  Nevertheless,  believing  in  the  quantity  theory,  and  taking 
into  consideration  other  factors,  of  which  some  are  mentioned  in 
these  pages,  the  writer  thinks  that  the  tendency  for  some  time  to 
come  will  be  toward  slightly  higher  prices,  but  that  we  have  already 
discounted  a  large  part  of  the  quantitative  effects  of  the  gold  supply 
of  the  next  decade  or  two. 

1557.  If  this  view  is  correct,  there  is  no  reason  for  diverting 
funds  which  are  properly  destined  for  investment,  into  speculative, 
or  semi-speculative  channels.  The  few  instances  of  pecuniary  gain 
that  might  result  from  so  doing  would  not  compensate  for  the 
greater  average  losses  which  inevitably  attend  the  assumption  of 
commercial  risk. 

1558.  The  Relation  of  Commodity  Prices  to  Bond  Prices.  The  rela- 
tion of  bond  prices  to  the  net  interest  rate  or  income  (as  distin- 
guished from  the  cash  or  coupon  rate)  has  been  completely  can- 
vassed in  the  chapters  on  bond  mathematics.  There  remains  only 
to  show  the  relation  between  commodity  prices  and  interest  rates 

1  The  line  marked  "3"  running  from  1866  to  1880  reduces  the  actual  prices  for 
the  intervening  years  to  terms  of  gold. 


512  THE  FUTURE  OF  BOND  PRICES 

in  general.  On  this  point  there  is,  and  1ms  been  for  a  century,  no 
difference  of  opinion,  although  misconception  among  business  men 
who  have  not  given  thought  to  the  subject  is  very  common. 

1559.  Superfluity  of  gold  does  not  imply  lower  interest  rates. 
The  natural  assumption  is  that  the  more  abundant  money  becomes, 
the  less  useful  each  unit  will  be,  and  therefore  the  less  it  will  cost, 
in  terms  of  interest,  to  borrow  money.  Indeed  this  is  the  first  and 
temporary  effect  of  an  influx  of  gold,  from  whatever  source.  The 
gold  naturally  first  finds  its  way  into  bank  reserves,  and  results 
in  comparative  money  ease.  The  error  in  assuming  the  same  lower- 
ing of  interest  rates  on  long-time  loans  arises  from  a  confusion  of 
capital,  or  wealth,  with  its  medium  of  exchange. 

1560.  According  to  the  quantity  principle,  an  increase  in  the 
money  units,  or  a  decrease  in  their  value,  does  not  alter  the  amount  of 
wealth  in  the  world;  does  not  alter  the  value  of  the  units  of  capital. 

Suppose  5  per  cent,  per  annum  is  the  difference  between  the  pres- 
ent and  the  future  worth  of  capital.  This  means  that  the  business 
man  can  be  reasonably  certain  of  earning  5  per  cent,  with  real 
capital.  Assume  that  the  money  to  purchase  this  capital  is  bor- 
rowed, and  at  the  end  of  the  year  is  returned,  having  earned  5  per 
cent.  Assume  also  that  during  the  year  the  purchasing  power  of 
money  has  decreased.  The  lender  may  actually  have  been  paid  only 
4  per  cent,  in  purchasing  power.  He  may  not,  and  probably  will 
not,  be  aware  of  the  disadvantageous  situation  in  which  he  has  been 
placed.  If  he  is  aware  he  will  be  unwilling  to  enter  into  a  new  con- 
tract for  loan  except  at  an  interest  rate  (6  per  cent.)  that  will 
take  into  account,  not  only  the  earnings  to  which  real  capital  is 
entitled,  but  also  the  loss  in  monetary  capital  through  depreciation. 
Even  if  unaware,  he  and  his  fellow  lenders  would  approximate  in 
their  demands  the  compensation  in  interest  which  a  depreciating 
currency  makes  necessary,  because  this  very  depreciation  makes  the 
money  profits  of  business  much  larger  than  the  real  profits,  and 
invites  increased  competition  in  business  activity  with  increased 
competitive  bidding  for  capital. 

1561.  This  action  of  the  blind  leading  the  blind  has  been  called 
the  equilibrating  action  of  interest  rates.  It  tends  to  maintain 
justice  between  borrower  and  lender.  In  so  doing,  while  money 
(gold)  is  appreciating,  it  tends  to  lower  the  interest  rate  on  bonds 
and  other  long  deferred  payments,  and  therefore  to  increase  their 
price;  but  while  money  (gold)  is  depreciating,  it  tends  to  increase 
the  interest  rate  and  therefore  to  lower  their  price. 


CHAPTER  XL 
THE  BOND  HOUSES 

1562.  The  Bond  Business.  That  part  of  the  public  which  does  not 
buy  bonds  has  little  idea  of  the  importance  and  value  to  the  com- 
munity of  the  bond  business.  It  is  not  necessary  to  resort  to 
many  figures.  It  is  only  necessary  to  realize  that  bonds  are  the  chief 
resource  of  our  government  in  times  of  war,  of  our  states  and  mu- 
nicipalities in  furtherance  of  public  works  and  buildings,  of  our 
railroads,  of  almost  all  public  service  corporations  and  many  in- 
dustrial corporations.  In  round  numbers,  $1,500,000,000  of  Ameri- 
can bonds  are  marketed  every  year  and  almost  all  of  them  pass 
through  the  hands  of  American  bond  houses.  Even  those  issues  of 
which  the  ultimate  nominal  market  is  the  New  York  Stock  Ex- 
change are  first  offered  and  sponsored  by  dealers  in  bonds.  In 
volume  and  number  the  transactions  on  the  exchange  are  only  a 
mere  fraction  of  those  in  direct  merchandising.  Of  this  $1,500,000,- 
000  of  bonds  one-third  is  absorbed  by  insurance  companies,  savings 
banks,  trust  companies  and  other  banks  (in  approximately  equal 
amounts)  and  the  remaining  two-thirds  by  corporations  (for  re- 
serve, etc.)  and  by  private  investors  in  this  country  and  abroad. 

1563.  In  view  of  the  vast  importance  of  the  bond  business  in  the 
economic  life  of  the  country,  it  is  surprising  that  so  little  is 
known  about  bonds  and  the  bond  business.  No  one  who  has  had 
experience  in  selling  bonds  will  deny  that  the  "  average  man  "  who 
has  accumulated  a  surplus  is  far  more  conversant  with  stocks  and 
the  basic  principles  of  stock  speculation  than  with  bonds  and  the 
principles  of  bond  investment.  The  reason,  however,  is  not  far  to 
seek.  While  human  nature  remains  what  it  is,  the  element  of  chance, 
with  its  exhilarating  risk,  will  be  more  attractive  to  men  than  the 
element  of  approximate  certainty  that  is  arrived  at  by  painstaking, 
uninspired  care.  Since  the  stock  market  is  more  interesting  and 
problematical  than  the  bond  market  to  the  majority  of  readers, 
journalism,  in  the  course  of  its  duty  to  purvey  to  the  majority, 

513 


514  THE  BOND  HOUSES 

perennially  fills  its  financial  pages  with  lime-honored  summaries  of 
yesterday's  exchange  doings,  to-day's  gossip,  and  circumspect  con- 
jectures as  to  the  morrow. 

1564.  Although,  relatively  speaking,  the  number  of  people  con- 
versant with  bonds  is  small  through  the  country  at  large,  it  is  some- 
times surprising  to  find  what  a  large  proportion  of  the  well-to-do 
in  the  Northeastern  States,  which  have  been  educated  to  bond  buy- 
ing, have  at  some  time  or  other  bought  bonds.  Every  Eastern  bond 
house  has,  or  ought  to  have,  a  list  of  at  least  70  per  cent,  of  all  the 
bond  buyers  of  consequence  in  most  cities  or  towns  in  New  England. 
A  comparison  of  this  list  with  a  list  of  all  persons  estimated  to  be 
worth  $50,000  or  more,  whether  bond  buyers  or  not,  will  prove  the 
prevalence  of  general  bond  buying  in  this  section. 

1565.  The  leading  banking  houses  were  not  always  primarily 
bond  houses.  Two  generations  ago  financial  business  was 
transacted  by  "  bankers  and  brokers."  Bond  selling  was  an  incident 
to  the  general  banking,  exchange,  and  brokerage  routine.  It  was 
all  done  "  over  the  counter."  There  was  comparatively  little  im- 
plied responsibility  on  the  part  of  the  vendor.  In  the  age  of  Com- 
modore Vanderbilt,  the  elder  Gould,  Fisk,  and  Drew  the  "  caveat 
emptor  "  principle  of  exchange  was  accepted  and  the  devil  took  many 
beside  the  hindmost.  But  now  the  speculative  business  in  New  York, 
so  far  as  it  is  reputable  and  consequential,  is  done  by  "  Members  of 
the  New  York  Stock  Exchange  "  and  the  investment  business  is  done 
by  "  Bankers,  Dealers  in  Investment  Bonds."  Of  course,  a  house 
marketing  investment  securities  may  have  a  seat  on  one  of  the  ex- 
changes, but  it  is  accepted  and  understood  that  the  firm  specializes 
in  one  or  the  other  of  these  two  forms  of  business.  The  financial 
atmosphere,  the  financial  temper,  and  the  training  necessary  to  su- 
perior service  in  either  occupation  have  accomplished  the  severance 
of  stock  dealing  and  bond  selling. 

1566.  The  Functions  of  the  Bond  Houses.  The  primary  function 
of  the  bond  house  is  to  obtain  capital  for  the  creation  of  new  enter- 
prises or  the  enlargement  of  old.  So  far  as  concerns  these  houses 
in  their  proper  capacity  the  capital  obtained  is  in  the  form  of  loans. 
The  houses  purchase  the  loans  outright  for  their  own  account  and 
resell  to  their  clients.  As  in  any  sort  of  merchandising,  there  are 
few  wholesalers  and  many  retailers.  The  prominent  "  wholesale  " 
bond  dealers,  numbering  less  than  a  dozen,  confine  themselves  for 
the  most  part  (as  far  as  American  corporation  loans  are  concerned) 
to  the  great  railroad  systems.     They  have  few,  if  any,  traveling 


THE  BOND  HOUSES  515 

representatives.  Their  sales,  in  this  country,  are  effected  by  public 
subscription,  stimulated  through  extensive  advertising,  and  by  dis- 
tribution to  large  institutions,  such  as  the  insurance  companies, 
and  to  the  smaller  bond  houses. 

1567.  Now  it  is  only  fair  to  state  that  the  wholesale  inter- 
national bankers  have  not  been  trained  by  the  necessities  of  the  per- 
sonal relation  between  client  and  financial  adviser  to  accept  and 
offer  only  such  securities  as  they  would  be  willing  to  keep  for  their 
own  account.  It  is  not  necessary  to  illustrate,  but  none  of  the 
typical  American  "  retail  "  bond  houses  could  have  the  hold  many 
of  them  do  have  upon  their  customers  if  they  had  recommended  and 
sold  a  tithe  of  the  bonds  and  stocks  that  have  been  distributed  by 
some  of  the  international  bankers.  Mere  magnitude  in  the  capitaliza- 
tion of  a  bond  house  or  of  an  obligor  corporation  is  still  a  thing  to 
conjure  with  in  America.  Financial  history  does  not  support  the 
view  that  there  is  safety  in  size.  Since  the  international  houses, 
with  special  spheres  of  usefulness,  do  not  best  represent  the  things 
for  which  the  bond  houses  stand,  and  since  the  contact  of  private 
investors  is  with  representatives  of  the  retail  houses,  this  article  is 
concerned  only  with  the  latter. 

1568.  "  Ketail  "  is  not  a  term  properly  descriptive  of  the  firms  in 
mind,  although  it  suggests  the  relative  size  of  the  issues  handled 
and  the  relative  volume  of  business.  It  misleads  if  it  suggests  that 
the  main  business  of  such  houses  is  to  distribute  among  small  in- 
vestors issues  that  originally  were  investigated  and  purchased  by 
"  wholesale  "  houses.  This  is  not  the  case.  For  the  most  part  each 
of  the  American  bond  houses  buys  its  issues  independently,  in  accord- 
ance with  its  policy  regarding  investments,  or  it  buys  them  in  "  joint 
account "  with  other  houses  having  similar  policies.  These  houses 
are  autonomous;  their  prosperity  is  built  on  their  ability  to  find  and 
obtain,  on  the  one  hand,  funded  obligations  that  merit  investment, 
and  on  the  other,  a  clientele  that  has  faith  in  them  and  their  busi- 
ness judgment  and  probity. 

1569.  The  success  of  the  bond  houses  in  weathering  financial 
storms  while  stock  exchange  houses  have  gone  down  by  the  score,  is 
strong  support  of  the  contention  that  bond  investment  rests  on  a 
basis  of  principles  reducible  to  a  science.  The  writer  knows  of  not 
one  important  investment  house  that  has  failed  except  through 
deliberate  violation  of  perfectly  well-known  investment  principles 
or  through  equally  deliberate  fraud.  There  is  no  business  in  all 
the  country  that  has  placed  itself  on  more  enduring  foundations  of 


516  THE  BOND  HOUSES 

business  wisdom,  or  that  is  conducted  on  a  higher  plane  of  business 
ethics. 

1570.  Enough  has  been  said  of  the  great  services  of  the  American 
bond  houses.  Without  their  help  it  would  be  impossible  to  finance 
American  enterprises  upon  equally  favorable  terms.  By  their  ultra- 
conservatism  they  are  establishing  themselves  in  public  confidence 
in  a  way  to  bring  together  with  the  greatest  expedition  and  least 
middleman's  cost  the  promoters  of  our  national  resources  and  the 
creditor  class  from  whom  must  come  the  capital  necessary  to  mu- 
nicipal and  industrial  development.  They  extend  the  boundaries  of 
credit  and  exercise  a  directive  and  steadying  iniluence  upon  enter- 
prise. By  preaching  the  principles  of  bond  buying  in  advertise- 
ments, pamphlets,  correspondence,  and  in  personal  interviews  by 
bond  salesmen  they  are  slowly  but  surely  converting  the  American 
people  into  a  nation  of  investors.  It  will  be  worth  while  to  examine 
in  greater  detail  the  several  functions  they  perform. 

1571.  The  Purchasing  Function.  If  a  municipal  loan  is  offered, 
the  purchase  is  a  comparatively  simple  matter,  provided  the  mu- 
nicipality is  well  known  to  the  fraternity.  Then  no  preliminary 
investigation  is  required;  a  bid  is  made  for  the  loan  at  the  current 
market  rates  and  acceptance  on  award  is  subject  to  the  approval 
of  the  bidder's  attorney  in  all  respects  affecting  the  validity  of  the 
obligation. 

If  the  municipality  is  not  well  known  to  the  bidder,  a  qualified 
representative  will,  or  should  be,  sent  to  learn  at  first  hand  the 
physical  and  financial  condition  of  the  city  and  to  form  an  esti- 
mate of  its  probable  future  willingness  and  ability  to  meet  its  pres- 
ent and  future  obligations. 

If  a  corporation  loan  is  offered,  it  will  probably  be  submitted  at  the 
offices  of  the  bankers  by  a  representative  of  the  company  or  by  a 
promoter.  If  the  applicant  is  of  a  social  turn  of  mind  he  will 
probably  not  lack  the  company  of  his  kind  in  the  anteroom.  Com- 
petition, fortunately,  is  keen. 

The  first  step  in  the  process  of  elimination  (there  is  more  elimina- 
tion than  acceptance)  is  to  discard  the  propositions  of  companies 
that  conduct  a  kind  of  business  unfamiliar  to  the  bankers.  Except 
under  unusually  favorable  circumstances  the  highest  grade  of  bond 
houses  will  not  purchase  bonds  of  industrial  corporations,  mining 
or  irrigation  companies,  etc. 

The  next  step  is  to  discard  loans  that  have  not  a  claim  on  prop- 
erty worth,  under  the  most  unfavorable  conditions,  more  than  the 


THE  BOND  HOUSES  517 

amount  of  the  obligation  secured.  Most  corporations  will  bond 
themselves  in  as  large  a  sum  as  their  bankers  will  permit.  Loans 
are  continually  being  rejected  because  of  insufficient  equity  in  prop- 
erty values. 

The  third  step  is  to  discard  those  propositions  which  do  not  give 
reasonable  assurance  of  earning  at  all  times  at  least  50  per  cent, 
more  than  all  fixed  charges,  after  making  extremely  liberal  esti- 
mates for  future  increased  operating  expenses. 

The  fourth  step  is  to  decline  loans  to  companies  conducted  by 
men  or  with  methods  which  do  not  meet  with  approval. 

1572.  If  the  house  is  satisfied  by  interview  and  correspondence 
in  matters  of  the  above  nature,  and  if  a  suitable  price  can  be  agreed 
upon,  then  engineers  and  accountants  may  be  sent  to  the  plant 
and  offices  to  make  a  thorough  examination ;  and  the  members  of  the 
firm,  with  counsel,  meet  officers  of  the  company  and  their  attorneys 
to  settle  the  matters  of  form.  On  acceptance  of  an  issue  a  careful 
banking  house  may  demand  representation  on  the  directorate  of  the 
company  until  such  time  as  the  company  shall  have  discharged  its 
bonded  obligation. 

1573.  Illustrating  the  care  with  which  properties  are  examined, 
the  writer  recently  had  occasion  to  inspect  an  interurban  line  in 
Pennsylvania  and  incident  to  mileage  cost  of  construction  inquired 
in  jest  the  number  of  ties  between  the  terminal  and  a  certain  city 
some  miles  distant.    "  We  don't  know,"  replied  one  of  the  owners  of 

the  road,  "  ask  your  engineer,  Mr. .    He  has  photographs  of 

every  foot  of  the  line  and  can  count  the  ties  for  you,  but  probably 
he  has  already  counted  them." 

1574.  There  is  a  difference  in  the  degree  of  care  exercised  by 
various  houses.  The  ultra-conservative  will  not  permit  their  names 
to  be  associated  with  "  construction  propositions."  They  will  con- 
sider for  purchase  the  obligations  of  only  seasoned  companies  with 
established  earning  power. 

The  reactionary  effect  of  the  stringent  requirements  of  bond  houses 
is  of  inestimable  benefit  to  corporation  finance,  but  its  good  influence 
has  a  wider  sphere;  it  embraces  municipal  corporations  and  mu- 
nicipal finance.  American  bond  houses  have  put  municipal  bond 
buying  on  an  entirely  different  plane  from  what  it  was  in  1875.  In 
this  they  have  been  helped  by,  and  have  helped,  the  development  of 
municipal  bond  law.  In  these  days  cities  and  towns  that  have  had 
much  experience  placing  bonds  will  be  certain  in  advance  of  their 
advertisements  for  bids  that  the  loan  has  been  issued  in  conformity 


518  THE  BOND  HOUSES 

with  (he  exacting  requirements  of  the  bond  attorneys.  Certain 
strong  Canadian  houses  command  such  respect  in  their  country  that 
they  have  been  able  to  direct  (he  Legislation  of  the  Western  provinces 
to  the  end  that  the  Western  loans  may  be  more  acceptable  to  the 
investors  in  the  Eastern  provinces  and  in  England. 

1575.  The  Advisory  Function.  This  advisory  and  directive  func- 
tion is  more  prominently  operative  in  bond  selling  than  in  bond 
buying.  It  has  its  source  in  the  statistical  departments  which  every 
house  of  quality  must  maintain.  It  finds  its  chief  expression,  as 
already  slated,  in  tabloid  investment  lessons,  printed  in  the  adver- 
tising columns  of  newspapers  and  periodicals,  or  with  somewhat 
greater  fullness  in  pamphlets  and  monographs.  If  a  prospective 
client  has  an  investment  policy  that  is  apparently  not  suited  to  his 
particular  needs,  the  home  office  may  tactfully  direct  his  attention  by 
letter  or  through  their  representative  in  his  territory  to  a  means  by 
which  he  may  better  his  position.  Some  bond  houses  maintain  a 
daily  news  sheet  for  the  benefit  of  their  salesmen  in  which  are 
printed  not  only  pertinent  items  of  current  interest,  but  timely  dis- 
cussions of  different  problems. 

Activities  of  this  nature,  developed  to  their  logical  conclusion, 
can  lead  to  only  one  result,  the  establishment  of  the  American  bond 
houses  in  the  confidence  of  the  public  as  their  chief  advisers  in 
financial  matters,  in  some  such  relation  as  the  great  banks  of  France 
and  Germany  bear  to  investors  in  those  countries.  Even  now  a  few 
of  the  better  houses  can  count  upon  the  absorption  by  their  friends 
among  institutions  and  investors  of  a  certain  amount  of  any  issue 
they  recommend  and  offer. 

This  advisory  function  can  become  general  and  economically  sound 
only  as  the  bond  houses  as  a  class  recognize  the  scientific  and 
professional  nature  of  their  calling  and  guide  their  movements  and 
policies,  as  do  the  governors  of  the  Bank  of  England,  let  us  say, 
alive  to  the  power  of  their  position  and  their  responsibility  as 
repositories  of  a  nation's  confidence. 

1576.  The  Banking  Function.  Illustrative  of  the  relation 
between  house  and  client,  there  has  arisen  the  demand  that  banking 
departments  be  established  for  the  safe  keeping  of  funds  destined, 
upon  enlargement,  to  go  into  investment,  and  also  to  accommodate 
those  who  wish  to  purchase  securities  before  they  have  sufficient 
funds  to  pay  in  full  for  them.  From  the  necessities  of  these  two 
situations  it  is  only  a  short  step  to  the  conduct  on  a  small  scale  of 
a  bank  of  deposit  subject  to  check.     But  properly  and  ordinarily, 


THE  BOND  HOUSES  519 

the  banking  department  of  a  bond  house  is  conducted  as  a  matter  of 
accommodation  to  its  customers  and  not  primarily  to  do  a  general 
banking  business.  From  these  beginnings  it  sometimes  has  hap- 
pened that  a  full-fledged  bank  has  been  evolved,  in  which  the  sav- 
ings, deposit,  and  trust  functions  of  the  bank  have  balanced,  nomi- 
nally at  least,  the  sales  function  of  the  bond  house,  but  an  excep- 
tion of  this  sort  would  only  prove  the  rule.  Although  bond  houses 
are  banks,  technically,  and  are  entitled  to  their  common  designation, 
"  bankers,"  nevertheless,  on  the  principle  that  security  selling  is  not 
best  undertaken  by  obligor  companies  but  is  properly  left  to  the 
bond  houses  which  make  it  a  profession,  so  the  general  banking  busi- 
ness is  best  left  to  banks  proper. 

1577.  Bond  houses  which  do  business  in  New  York  State  (and 
that,  of  course,  includes  the  principal  houses  of  the  country) 
were  recently  threatened  with  a  handicap  in  the  accommoda- 
tion of  their  customers  by  the  new  state  law  requiring  private 
banks  in  which  the  deposit  accounts  for  the  previous  year  aver- 
age less  than  $500  cash  to  give  a  heavy  bond  and  exhibit  a  de- 
tailed statement  of  their  condition  or,  in  lieu  of  the  statement, 
deposit  with  the  state  a  considerable  fund  in  securities.  Of 
course  this  law  was  aimed  at  the  private  bankers  with  whom 
the  foreign  element  of  our  population  is  accustomed  to  deal,  and 
in  the  main  it  is  good.  Although  it  will  be  an  inconvenience  to 
some  bond  houses,  it  is  to  be  welcomed  as  another  element  of  strength 
in  the  financial  system. 

1578.  The  Bond  Houses  as  Fiscal  Agents.  Because  of  purchasing, 
advisory,  and  banking  functions  bond  houses  are  called  upon  to 
act  as  fiscal  agents  for  corporations,  municipalities,  and  even  states. 
The  long  standing,  friendly  banking  relations  of  the  older  firms 
with  the  Western  cities  recall  the  fact  that  interest,  and  sometimes 
the  principal,  of  the  loans  of  these  cities  is  payable  at  the  offices 
of  the  bond  house.  Here  and  there  an  Eastern  institution  is  met 
that  will  not  buy  Western  municipals  which  are  not  payable  in  the 
East.  This  is  not  so  much  to  save  the  cost  of  conversion  into  New 
York  funds,  for  that  might  be  arranged  in  the  price,  as  because  of  the 
inconvenience  and  possible  loss  of  interest  in  shipping  the  bonds  west 
for  collection.  Some  of  the  older  bond  houses  act  as  depositories 
for  Western  cities.  In  general,  the  conduct  of  the  bond  houses  as 
fiscal  agents  has  merited  the  trust  placed  in  them. 

1579.  It  is  natural  that  private  corporations  will  look  to  the 
bond  houses  as  their  financial  agents.    The  disposition  of  a  com- 


520  THE  BOND  HOUSES 

pany's  funded  loans  is  not  merely  a  matter  of  merchandising;  it  is 
natural  that  the  relationship  begun  by  the  purchase  of  bonds  and 
banking  representation  on  the  directorate  shall  be  continued  in- 
definitely in  the  thought  of  future  financial  needs.  Just  as  the  great 
railroad  systems  have  their  long  established  financial  connections 
with  certain  large  houses,  so  the  public  service  and  other  private  cor- 
porations form  alliances  with  the  bond  houses.  The  continuance  of 
such  relations  implies  conformity  on  the  part  of  the  obligor  cor- 
porations with  the  policy  of  the  bond  houses.  This  also  tends  to- 
ward a  betterment  of  financial  conditions  throughout  the  country. 

1580.  The  Selling  Function.  American  banking  houses  are  not 
eleemosynary.  Whatever  may  be  their  usefulness  in  the  community, 
it  is  the  result  of  that  enlightened  self-interest  which  used  to  be 
expressed  in  the  phrase  "  Honesty  is  the  best  policy."  Their  reason 
for  being  is  to  make  money  by  selling  bonds,  and  the  competition 
is  getting  keener  every  day.  Many  of  the  ordinary  effects  of  com- 
petition are  noticeable  in  the  bond  business.  There  is  standardiza- 
tion of  wares  and  policies,  there  is  diminution  in  ratio  of  profits. 
But  two  ordinary  effects  of  competition  are  conspicuously  absent. 
There  is  no  deterioration  of  the  product  and  no  tendency  toward 
consolidation  among  the  vendors. 

1581.  The  relation  of  supply  and  demand  for  securities  is  totally 
different  with  us  from  what  it  is  in  England  or  France.  Our  in- 
dustrial development  more  than  keeps  pace  with  our  investment 
resources.  We  are  less  dependent  on  foreign  capital  than  ever  be- 
fore, but  not  so  rich  that  funds  awaiting  conservative  employment 
have  not  a  choice  of  excellent  opportunities  at  home. 

By  reason  of  this  very  competitive  bidding  by  capital  the  quality 
of  our  loan  product  offered  by  good  bond  houses  is  not  cheapened. 
In  the  process  of  soliciting  business  by  advertisement  and  interview, 
American  investors  are  becoming  educated  in  investment  principles 
and  reward  with  most  patronage  the  houses  that  give  the  best  evi- 
dence of  living  up  to  investment  ideals.  It  is  the  same  in  this  as  in 
the  legal  and  medical  professions.  It  pays  best  in  the  long  run  to 
be  technically  competent. 

1582.  Since  the  principal  point  of  contact  between  investors  and 
banking  houses  is  through  traveling  representatives  whose  advice  is 
followed  to  a  very  material  extent  by  investors,  the  salesmen  sent 
out  are  of  more  than  average  intelligence  and  business  ability.  The 
large  majority  of  those  representing  the  better  concerns  are  college- 
bred  men.    The  alert  sales  manager  will  keep  in  touch  with  the  col- 


THE  BOND  HOUSES  521 

leges  and  universities  and  will  seek  to  obtain  for  his  firm  men  of 
the  graduate  schools  or  of  the  graduating  class  who  give  promise 
of  ability  in  salesmanship  not  only  by  their  record  in  college  activi- 
ties but  by  their  appearance  and  address.  Most  of  these  men  will 
serve  office  apprenticeships  of  length  before  they  are  sent  out  on 
the  road. 

1583.  The  other  effect  of  competition'  that  we  mentioned  as  lack- 
ing is  the  tendency  toward  consolidation.  The  absence  of  it  is  fur- 
ther evidence  of  the  peculiarly  professional  relation  which  subsists 
between  the  banking  house  in  its  advisory  capacity  and  the  client. 
It  raises  bond  selling  from  a  business  to  a  profession. 

1584.  There  are  some  who  profess  to  see  in  the  gradual  evolution 
of  the  bond  business  a  tendency  to  relinquish  direct  selling  from 
house  to  client  through  traveling  salesmen  in  favor  of  distribution, 
on  a  commission  basis,  through  local  independent  bankers.  This  may 
come.  If  it  should,  it  would  be  one  of  the  evil  effects  of  competition. 
It  would  relieve  the  "  retail  "  houses  of  a  large  part  of  that  sense  of 
personal  responsibility  which  they  now  feel.  They  would  be  in  a 
position  analogous  to  that  of  the  wholesale  houses  at  present.  In- 
vestors would  have  to  accept  offerings  from  those  who  had  no  part 
in  the  investigation  which  preceded  the  original  purchase  of  the 
issue,  and  who,  presumably,  would  not  have  the  capital  or  organiza- 
tion of  distribution  to  "  protect  the  market "  for  the  benefit  of 
those  who  might  wish  subsequently  to  sell  their  securities. 

1585.  The  Protective  Function.  There  is  a  radical  difference  in 
the  attitude  of  bond  houses  in  this  matter  of  repurchasing  securi- 
ties of  clients  to  whom  they  have  sold  them.  Some  take  the  stand 
that  a  sale  is  a  sale,  and  the  responsibility  of  a  house  that  has  acted 
in  good  faith  ceases  upon  delivery  of  the  bond  and  the  receipt  of  pay- 
ment. This  position  is  logical  and  just,  but  again  competition  steps 
in  to  benefit  the  customer.  Other  houses  say :  "  We  shall  put  out  our 
issues  as  nearly  as  possible  on  a  plane  of  marketability  with  active 
listed  securities.  We  make  no  promises,  but,  except  in  times  of 
panic  when  it  may  be  impossible  to  raise  money  to  satisfy  everybody, 
we  hope  and  expect  to  be  so  situated  as  to  buy  back  at  the  fair 
market  price  the  securities  we  have  sold."  The  substance  of  this 
statement  is  now  occasionally  seen  in  advertisements  over  the  signa- 
ture of  a  few  of  the  better  and  stronger  houses.  Few  investors 
realize  the  full  significance  of  this  protective  market  policy.  They 
are  inclined  to  remember  that  they  may  buy  most  of  the  active 
listed  bonds  on  the  exchange  and  sell  them  the  same  day  at  an 


522  THE  BOND  HOUSES 

average  total  loss,  due  to  the  "  higgling  of  the  market,"  of  perhaps 
only  2  points  or  so.  They  do  not  realize  that  on  a  declining  bond 
market  they  may  have  to  take  an  additional  loss,  in  listed  bonds,  of 
say  8  points,  or  10  points  in  all,  whereas  in  the  same  circumstance 
a  bond  house  would  think  twice  before  quoting  a  client  a  price  10 
points  below  the  previous  selling  price.  And,  to  say  nothing  of  in- 
vestment guidance,  nine  times  out  of  ten  the  issue  of  the  bond  house 
is  yielding  at  least  ^  more  per  annum  than  an  equally  sound  listed 
issue. 

1586.  But  the  protective  function  of  the  bond  house  is  most  im- 
portant in  respect  to  the  moral  responsibility  of  "  seeing  clients 
through "  default,  reorganization,  and  rehabilitation  in  the  ex- 
tremely rare  cases  in  which  trouble  arises.  In  some  instances 
losses  amounting  to  hundreds  of  thousands  of  dollars  have  been 
made  good;  in  many  instances  the  firms  have  volunteered  to  pay 
interest  which  has  been  suspended;  in  every  case  a  reputable  bond 
house  will  feel  called  upon  to  take  the  active  leadership,  at  its  own 
expense,  in  upholding  the  mortgage  rights  or  other  legal  claims  of 
the  bondholders. 

With  the  enlightened  aid  of  bond  houses  the  creditor  class  will 
do  well  to  take  as  much  pains  in  the  investment  of  its  wealth  as 
in  the  acquisition  of  it.  Buyers  of  corporation  bonds  should  ex- 
ercise almost  as  much  care  in  the  selection  of  a  financial  adviser 
as  in  the  choice  of  a  security.  They  should  seek  a  bond  house  with 
a  strong  personality,  strong  convictions  on  investment  matters,  and 
the  capital  and  equipment  to  back  them  up. 


APPENDIX 

THE  GAMBLE  IN  "  GOVERNMENTS  "  BY  NATIONAL  BANKS 

By  W.  H.  Lyon 
Professor  of  Finance,  Tuck  School,  Dartmouth  College 

(Reprinted  from  Moody's  Magazine,  March,  1911.) 

1587.  We  had  on  January  1,  1911,  the  largest  amount  of  bank- 
notes outstanding  in  our  history— $727,980,000.  Why?  Not  be- 
cause business  demands  that  condition.  Gauged  by  bank  clearings 
business  for  1910  showed  a  small  but  real  recession  from  1909 
amounting  to  something  over  1  per  cent.  In  the  face  of  declining 
business  banknote  circulation  has  shown  a  very  substantial  increase 
of  over  $17,600,999,  or  1\  per  cent.    Again,  why? 

1588.  People  do  business  on  credit  and  for  cash.  Frequently 
by  "  cash  "  we  mean  immediate  payment,  and  by  "  credit  "  we  mean 
deferred  payment.  A  nicer  use  of  the  words,  however,  indicates 
something  a  little  different.  We  may  put  through  a  credit  transac- 
tion and  at  the  same  time  have  immediate  payment.  If  both  parties 
to  a  transaction  are  business  men  they  carry  it  out,  unless  it  is  very 
small,  without  using  the  circulating  medium  we  commonly  call  cash, 
but  with  checks,  or  notes,  or  drafts.  The  check  makes  essentially 
immediate  payment,  yet  entirely  a  credit  transaction.  If  the  parties 
are  not  both  business  men,  or  if  the  transaction  is  very  small  they 
carry  it  out  by  the  exchange  of  cash.  Even  though  the  payment  be 
deferred,  it  is  in  our  present  sense  a  cash  transaction. 

If  the  total  volume  of  business  in  a  community  increases,  each  of 
these  two  divisions  will  increase.  Though  they  may  not  advance 
in  the  same  proportion,  each,  nevertheless,  will  grow  larger.  So,  as 
business  increases,  the  community  needs  at  the  same  time  more  credit 
and  more  cash. 

1589.  Banknotes  properly  used  satisfy  both  needs.  As  be- 
tween the  parties  they  are  cash;  as  between  either  party  and 
the  bank  they  are  credit.  The  notes  are  credit,  then,  in  all  transac- 
tions to  which  the  bank  is  party  and  cash  between  all  other  parties. 

523 


524  APPENDIX 

So  we  may  say  that  banknotes  properly  serve  two  purposes — they 
extend  credit  and  they  extend  the  circulating  medium.  Any  expan- 
sion of  business  requires  the  extension  of  both.  A  single  phrase  per- 
haps defines  the  banknote  better  than  any  further  statement  can. 
It  is  a  circulating  credit. 

1590.  Our  circulating  credit  doors  creak.  When  banks  buy  bonds 
direct  from  the  Government  to  issue  against  they  must  withdraw 
just  as  much  circulating  medium  as  they  put  out  in  notes.  Since 
Government  bonds  regularly  sell  at  a  premium,  they  withdraw 
even  more  "  cash  "  than  they  restore.  Real  increase  in  the  circu- 
lation  can  come  only  as  the  Government  pays  out  the  proceeds 
in  the  regular  course  of  its  expenditures.  Even  when  the  Govern- 
ment turns  round  and  deposits  the  proceeds  with  the  banks  pend- 
ing expenditure  this  does  not  add  to  the  circulating  medium,  for 
the  banks  must  then  buy  more  Government  bonds  to  secure  the 
deposits.     Such  depositing  only  adds  another  cog  to  the  process. 

If  the  banks  buy  Government  bonds  outstanding  in  the  hands 
of  investors  to  issue  notes  against  they  do  immediately  increase 
circulation.  Funds  paid  for  the  bonds  do  not  take  anything  out 
of  circulation,  and  the  new  notes  go  immediately  into  the  hands 
of  the  public.  But  at  the  time  of  the  panic  in  1907,  of  the  interest- 
bearing  debt  of  the  United  States  amounting  to  $894,834,280,  the 
banks  already  held  $774,732,297.  Imagine  the  position  of  the 
banks  going  out  to  buy  up  Government  bonds  to  any  reasonably 
adequate  amount  to  issue  circulation.  The  total  possible  supply 
was  only  a  little  more  than  $100,000,000.  And  Government  bonds 
do  not  yield  enough  for  dealings  as  a  speculative  security  in  large 
floating  supply.  Owners  hold  them  for  very  definite  reasons  and 
cling  to  them  tightly.  Bankers  buying  in  any  considerable  quan- 
tity would  sharply  bid  up  on  themselves  the  price  of  the  compara- 
tively few  available. 

1591.  So  much  for  the  part  our  notes  can  play  in  extending 
circulation.  Though  the  service  may  be  so  hampered  as  to  be 
largely  unavailing,  our  notes  in  a  way  can  perform  it.  But  the 
notes  cannot  directly  extend  credit  at  all.  To  procure  the  means 
of  purchasing  bonds  the  banks  must  first  contract  credit  as  much 
as  they  subsequently  expand  it.  As  far,  however,  as  the  notes 
make  possible  the  withdrawal  of  gold,  or  its  reserve  equivalent,  from 
hand  to  hand  circulation  and  its  use  as  a  reserve  to  base  compara- 
tively non-circulating  credits  on,  they  serve  their  credit  expansion 
purposes  as  well  as  any  notes. 


APPENDIX  525 

1592.  Whether  our  notes  when  issued  serve  their  purpose  well 
or  ill,  conditions  of  issue  are  such  that  our  bankers  cannot  work 
with  an  eye  single  to  the  needs  of  the  community  and  are  not 
sure  of  receiving  compensation  for  service  rendered.  Our  entire 
business  of  banknote  issue  takes  on  the  form  of  a  gigantic  specula- 
tion in  the  Government  debt.  Our  2s  of  1930  declined  from  110^ 
in  October,  1902,  to  100.75  in  January,  1911.  Allowing  for  the  loss 
of  about  3  points  due  to  the  eight  years  nearer  maturity,  this  is  a 
decline  of  6^  points— a  shrinkage  of  $42,000,000  on  the  issue.  Be- 
fore that  they  had  risen  from  103|  when  first  put  on  the  market  in 
July,  1900,  to  the  110^  in  October,  1902,  an  advance  of  nearly  7 
points  in  two  and  one-quarter  years  (adding  a  difference  of  about 
one-fifth  due  to  approaching  maturity),  an  increase  of  $45,200,000 
on  the  issue. 

1593.  What  is  the  point  of  all  this?  When  a  banker  takes  out 
currency  he  engages  in  two  distinct  transactions  and  enters  upon 
two  different  hazards.  In  one  transaction  he  assumes  the  risk  and 
holds  the  expectation  of  greater  profit  from  taking  out  circulation. 
Since  buying  bonds  and  taking  out  circulation  most  of  the  time 
shows  some  theoretical  profit  over  loaning  direct,  presumably  if 
there  were  no  other  consideration,  most  of  the  time  our  bankers 
would  keep  outstanding  all  the  notes  they  could.  In  the  other 
transaction,  however,  the  banker  engages  in  a  speculation  in  Gov- 
ernment securities.  As  a  matter  of  fact,  if  the  price  of  Government 
bonds  advances,  the  profit  from  taking  out  circulation  declines ;  but 
our  banker  is  pretty  likely  to  view  with  equanimity  the  declining 
circulation  profit  when  he  considers  the  profit  he  is  making  in  his 
speculation  in  bonds.  On  the  other  hand,  as  the  price  of  Govern- 
ment bonds  declines,  circulation  grows  more  profitable.  The  banker 
is  likely  to  view  this  with  sour  satisfaction  when  he  looks  on  his 
loss  in  his  bond  speculation.  Profit  or  loss  in  the  bond  speculation 
is  likely  to  outbalance  loss  or  profit  in  the  circulation  transaction. 

1594.  Let  us  examine  the  case  more  closely.  Just  what  is  the 
profit  or  loss  from  taking  out  circulation?  In  the  first  place  the  bank 
gets  the  regular  current  money  rates  on  the  loans  it  makes  through 
issuing  notes.  Also  it  gets  the  interest  on  the  Government  bonds 
it  buys.  This,  of  course,  means  the  real  interest,  or  income  on  the 
investment,  called  basis,  taking  into  consideration  coupon  interest, 
price  paid  and  date  of  maturity.  Excepting  for  the  tax  of  -J  per 
cent,  on  the  circulation  taken  out  ( 1  per  cent,  if  taken  out  on  the  3s 
or  4s)  and  for  the  expenses  attendant  on  taking  out  circulation, 


526  APPENDIX 

which  the  Government  actuaries  compute  to  average  $03  on  the 
$  100,000,  this  interest  on  the  Government  honds  looks  like  clear 
"  velvet."  It  would  he,  too,  if  the  banker  did  not  have  to  pay 
more  for  the  bonds  than  the  amount  of  circulation  he  can  take 
out  against  them.  To  figure  his  nel  profit,  lie  must  deduct  from  the 
gain  items  just  stated  what  he  would  have  made  if  he  had  loaned 
his  funds  direct  instead  of  investing  in  bonds. 

1595.  Expressed  as  an  algebraic  equation  the  situation  becomes 
much  clearer.     Let 

x  =  current  money  rate ; 

y  =  basis  rate  at  which  Government  bonds  are  bought ; 

z  =  price  of  Government  bonds ; 

b  =  circulation  received   ($100,00  used  as  basis  of  calculation)  ; 

c  —  taxes,  redemption,  and  other  circulation  expenses. 

(As  already  stated  Government  actuaries  have  calculated  that 
circulation  expenses  average  to  cost  the  banks  $03  on  the  $100,000 
of  circulation  taken  out.  Taxes  depend  on  whether  the  2s,  in 
which  case  the  tax  is  ^  per  cent,  or  the  3s  or  4s,  in  which  case  the 
tax  is  1  per  cent.,  are  bought.  Taxes,  then,  amount  to  either  b(.01) 
or  b(.005).  We  can  take  b  as  a  constant  in  our  calculations  and 
base  all  our  computations  on  taking  out  $100,000  of  circulation.) 

1596.  The  equation  of  profit  or  loss  on  taking  out  circulation 
then  reads : 

yz-)-bx — xz — e=profit  or  loss. 

But  circulation  taken  out  (b)  can  never  be  greater  than  the 
amount  of  money  paid  for  the  bonds  (z),  because  if  the  market 
price  of  bonds  should  decline  below  par  the  Comptroller  would 
compel  the  deposit  of  additional  bonds  sufficient  to  bring  the  market 
value  of  the  total  bonds  on  deposit  up  to  the  amount  of  circulation 
taken  out. 

1597.  If  Government  bonds  should  be  at  par  or  at  a  discount,  the 
nominal  profit  would  always  be  just  the  basis  interest  on  the  bonds, 
less  the  tax  and  the  cost  of  taking  out  circulation,  or  a  constant 
advantage  in  the  case  of  the  2s  of  1.437  per  cent. 

For  the  purpose  of  this  discussion  we  will  consider  only  the  2s 
of  1930.  Of  the  total  Government  debt  of  $913,417,490,  the  amount 
now  in  2s  is  $070,250,000  (figures  of  June  30,  1910).  Out  of  $079,- 
545,740  bonds  held  by  banks  to  secure  circulation  the  amount  in  2s 


APPENDIX  527 

is  |649,507,130  (October,  1909,  Comptroller's  report).  Out  of  the 
total  2s  outstanding  the  amount  of  the  issue  due  April,  1930,  is 
$646,250,150.  These  figures  will  justify  our  basing  the  discussion 
on  this  particular  issue. 

In  the  regular  case,  then,  the  money  paid  for  the  bonds  (z)  is 
greater  than  the  amount  of  circulation  received  (b).  With  that 
statement  in  mind  we  can  draw  certain  very  definite  conclusions 
about  our  circulation  direct  from  the  equation  we  have  formed; 
z  is  greater  than  b. 

Repeating  the  equation  in  order  to  have  it  directly  before  us : 

yz-f-bx — xz — c=profit  or  loss. 

Then  as  the  current  interest  rate  (x)  increases,  if  all  the  other 
quantities  remain  constant,  the  negative  influence  in  the  equation 
grows  greater,  or  profit  from  circulation  decreases.  We  can,  then, 
make  definitely: 

Statement  1 

1598.  If  all  other  circumstances  remain  the  same,  circulation 
grows  less  profitable  as  the  current  money  rate  advances. 

That  is  the  first  criticism  of  our  banknotes.  As  business  in- 
creases and  the  demand  for  both  credit  and  money  increases,  as 
reflected  in  the  rising  interest  rates,  taking  out  circulation  ceteris* 
paribus,  with  the  inexorability  of  a  mathematical  law  becomes  less 
profitable. 

Further,  there  is  an  intimate  relationship  between  y  and  z.  If 
the  price  of  bonds  (z)  declines,  the  basis  rate  (y)  must  advance. 
As  a  matter  of  fact  as  z  declines  yz  grows  greater.  If,  then,  x 
remains  constant  and  z  declines  the  influence  of  the  negative  quan- 
tities of  the  equation  is  growing  less.     Then  follows: 

Statement  2 

1599.  As  the  price  of  bonds  declines,  if  the  current  rate  remains 
constant,  the  profit  from  taking  out  circulation  increases. 

That  gives  the  absolute  mathematical  basis  for  such  general  state- 
ments as  that  "  the  price  of  bonds  is  too  high  to  make  circulation 
profitable." 

These  two  facts  set  out  in  Statement  1  and  Statement  2  place 
the  banker  who  has  taken  out  circulation  between  the  devil  and  the 


528  APPENDIX 

deep  blue  sea.  If  the  price  of  bonds  remains  the  same  and  the 
current  interest  rate  rises,  his  circulation  grows  steadily  less  profit^ 
able.  A  decline  in  the  price  of  bonds  affords  the  only  offset  to  an 
increasing  interest  rate.  But  if  the  price  of  bonds  declines  enough 
to  offset  the  advance  in  the  current  interest  rate,  the  banks  must 
mark  off  enough  profits  to  cover  the  loss  on  the  capital  value  of  the 
bonds. 

1600.  Speculating  in  securities  is  no  proper  part  of  a  bank's 
business.  It  is  an  anomalous  situation  that  in  order  to  fulfil  a 
proper  function  of  note  issue  a  bank  should  have  to  undertake  such 
an  improper  speculation.  A  bank  takes  its  normal  hazard  in  the 
risks  of  the  current  money  market.  It  makes  its  regular  profit  in 
what  it  receives  for  credit  (interest  on  its  loans)  over  what  it  pays 
for  credit  (interest  on  its  deposits)  plus  the  cost  of  management. 
This  hazard  of  the  money  market  the  bank  must  undertake  in  order 
to  do  business  at  all.  If  the  bank  takes  out  circulation  it  does  not 
avoid  this  hazard,  for  it  must  put  out  its  notes  on  a  loan,  but  it 
adds  a  new  hazard,  that  of  a  decline  in  the  price  of  its  bonds. 

1601.  How  does  speculation  in  securities  work  out  in  some 
particular  instances?  Commonly  we  have  an  increased  demand 
for  both  credit  and  the  circulating  medium  in  the  fall  to  "  move  the 
crops,"  and  this  increased  demand  makes  itself  known  in  rising 
money  rates.  In  order  to  work  out  our  equation  we  must  take  some 
value  for  x,  the  current  money  rate.  Since  the  banks  make  more 
than  one  class  of  loan  any  particular  money  rate  will  not  represent 
the  facts.  The  report  of  the  Comptroller  for  1909  states  the  per 
cent,  of  the  classes  of  loans  for  all  the  national  banks:  demand 
27.3  per  cent.,  time,  secured  by  stocks,  bonds,  etc.,  20.6  per  cent., 
two  name  paper  33.2  per  cent.,  single  name  paper  18.0  per  cent. 
To  get  some  money  rate  fairer  for  our  purpose  than  any  single 
rate  wTe  will  take  a  plain  average  of  the  New  York  call,  60  day,  and 
prime  paper.  In  New  York  City  demand  loans  amount  to  42  per 
cent.  Perhaps  such  a  plain  average  as  we  are  taking  comes  a  little 
nearer  for  New  York  and  the  New  York  rate  than  for  the  country 
at  large. 

For  1900  and  1901  this  average  rate  does  not  show  any  sharp 
increase  in  the  fall,  so  we  will  pass  over  these  years  as  not  indicat- 
ing any  clear  demand  for  an  extension  of  credit  and  currency.  In 
September,  1902,  however,  the  average  money  rate  went  to  7.38 
per  cent.  Suppose  a  banker  in  response  to  this  apparent  need  had 
taken  out  circulation  at  that  time.    Taking  the  average  price  of  the 


APPENDIX  529 

2s  of  1930,  he  paid  for  his  bonds  109,  securing  an  income  of  1.58 
per  cent.  In  February,  1903,  the  average  money  rate  fell  to  3.91  per 
cent.,  an  indication  that  the  country  no  longer  required  the  added 
currency.  During  the  intervening  period  the  current  money  rate 
averaged  6  per  cent.  The  banker  had  made  a  nominal  gain  in  taking 
out  currency  of  .6  of  1  per  cent.  Obeying  the  indication  of  the 
lower  interest  rate  the  banker  prepared  to  retire  his  circulation 
and  to  sell  his  bonds.  The  market,  however,  presented  him  with 
a  price  (average)  of  108.25,  a  loss,  including  1-16  commissions,  of 
|  per  cent,  in  five  months,  or  at  the  rate  of  2.1  per  cent.,  making 
a  net  loss  of  1.5  per  cent.,  or  in  dollars  an  actual  loss  of  $625  in 
five  months  on  $100,000  circulation. 

On  October  1,  1902,  total  circulation  stood  at  $366,993,598.  By 
February  28,  1903,  the  amount  outstanding  was  up  to  $382,198,845. 

Average  money  rate  went  up  again  through  March  and  April, 
but  in  May  fell  to  3.8  per  cent.  At  that  time  in  the  year  an  ad- 
vance is  improbable  till  fall.  If  our  banker  had  not  sold  his  bonds, 
however,  in  February  and  taken  his  loss  then,  he  would  in  May 
have  faced  a  still  further  decline  in  the  bond  price  to  an  average 
of  about  106.25,  two  points  more  in  two  months,  an  increase  in  his 
loss  of  nearly  $2,000  more.  Circulation  instead  of  declining  had 
risen  (May  31)  to  $406,443,205.  Nominal  profit  on  taking  out  cir- 
culation by  this  time,  on  account  of  the  decline  both  in  price  of 
bonds  and  the  current  interest  rates,  had  increased  to  1.53  per  cent. 
Those  who  had  circulation  could  not  retire  it  without  converting 
their  book  or  quotation  loss  into  an  actual  loss  taken,  and  those 
who  did  have  circulation  could  make  more  money  than  ever  in 
taking  it  out. 

In  the  fall  of  1903  the  regularly  expected  rise  in  the  current  inter- 
est rate  took  place.  Average  rate  rose  from  4.4  per  cent,  in  Septem- 
ber, through  5.2  per  cent,  in  October,  to  5.7  per  cent,  in  November. 
Average  price  bonds  in  November  was  106.75,  a  basis  of  1.68  per 
cent.  Indicated  profit  in  taking  out  circulation  under  these  condi- 
tions amounted  to  .835  per  cent.  The  average  money  rate  lasted  for 
two  months  and  fell  to  3.71  per  cent,  in  January,  1904.  By  that  time 
the  average  price  of  bonds  had  fallen  to  less  than  105,  a  decline  of  1.75 
points  in  two  months.  This  is  a  loss  at  the  rate  of  10.50  per  cent, 
a  net  loss  of  9.67  per  cent. ;  or,  in  terms  of  cash,  a  loss  of  $1,600  in 
two  months  on  $100,000  circulation.  As  might  be  expected  cir- 
culation continued  to  increase,  and  by  January  31,  1904,  had 
reached  $426,857,627. 


530  APPENDIX 

Money  rates  remained  steadily  low  from  January,  1904,  to  No- 
vember, 1905,  averaging  3.25  per  cent.  In  November,  1905,  the 
average  rate  went  up  to  6.66  per  cent.,  with  price  of  bonds  103.25. 
Money  remained  fairly  high  to  May,  1900.  If  a  banker  had  taken 
out  circulation  for  thai  period  lie  would  have  made  an  advantage  of 
.55  per  cent,  on  his  circulation,  and  might  have  sold  out  his  bonds  at 
103.75,  a  half  point  advance,  and  made  a  total  profit  of  one  point, 
or  2  per  cent. 

Next  September,  1906,  average  money  rate  rose  to  7.7  per  cent., 
and  was  fairly  high  till  April,  1907,  when  it  declined  to  4.08  per 
cent.  Bonds  were  selling  at  104.75  in  September  and  106.25  in 
April.  The  banker  would  have  made  .9  per  cent,  on  circulation 
and  1.5  points  profit  on  his  bonds,  a  total  of  2  points,  or  4  per  cent, 
advantage  in  the  circulation  transaction. 

For  the  panic  year  1907,  average  interest  rate  rose  in  October 
to  8.92  and  averaged  9.87  till  February,  1908,  when  it  fell  to  3.75. 
Bonds  in  October,  1907,  were  105.50  (average),  1.70  basis,  and  in 
February  averaged  practically  the  same.  So  a  banker  taking  out 
circulation  during  the  panic  for  the  first  time  neither  would  have 
made  or  lost  on  his  bond  speculation.  The  nominal  advantage  in 
taking  out  the  currency  was  a  small  enough  gain  considering  the 
hazard  of  the  bond  speculation. 

1602.  In  all  these  transactions  the  speculative  hazard  on  the 
bonds  far  outweighs  in  importance  any  question  of  need  for  circu- 
lation and  relative  profitableness  of  it. 

Enough  has  been  said  to  show  that  every  currency  transaction 
of  a  bank  is  essentially  two  transactions,  one  the  legitimate  banking 
business  of  note  issue,  relatively  unimportant  as  compared  with  the 
other  transaction,  the  speculation  in  the  Government  debt.  With 
the  particularly  uncertain  elements  entering  into  the  price  making 
of  the  bonds,  circulation  may  perhaps  not  improperly  be  called  a 
gamble  in  "  Governments." 


INDEX 


INDEX 


(The  references  are  to  section  numbers) 


Accrued  interest,  1324-1330;  as  a 
source  of  inaccuracy  in  the  bond 
tables,  1289. 

Ada  County,   Idaho,   498. 

Adjustment  bonds,  nature  of,  321,  665. 

Advertisement,  omission  or  insuffi- 
ciency of,  as  a  source  of  illegality  in 
municipals,  657. 

Advisory  function  of  the  bond  houses, 
1575. 

Age  of  a  city  as  affecting  its  credit, 
691. 

Alabama,  in  financial  difficulties,  391; 
in  default,  396,  397. 

Albany,  N.  Y.,  high  credit,  689. 

Allegheny  County,  Pa.,  bonds,  478. 

American  bond  market,  the,  78. 

American  Telephone  and  Telegraph  Co. 
bonds   as   undigested   securities,    174. 

American  Tobacco  Co.  Debenture  6s 
and  4s,  protection  for,  187. 

Amortization  and  accumulation,  tables 
or  schedules  of,  1380  et  seq. 

Amortization,  of  street  railway  bonds, 
1035;  of  state  bonds,  448;  of  tim- 
ber bonds,  1183-1187;  of  water  com- 
pany loans,  1098,  1099;  table  show- 
ing methods  by  which  it  is  accom- 
plished, 240. 

Annexation,  in  relation  to  statistics 
of  population,  585;  of  counties,  489- 
495. 

Anticipation  tax  warrants,  289. 

Apache  County,  Ariz.,  498. 

Application,  of  bank  discount  to  bond 
transactions,  1314-1321;  of  the  bond 
formulas,    1313. 

Appreciation,  as  a  speculative  and  an 
investment  virtue,  56;  as  affected  by 
premium  and  discount,  58;  bonds 
versus  mortgages,  153,  154;  of  real 
estate  debentures,  1136;  of  water 
power  bonds,  1123;  stocks  versus 
bonds,  84-86. 

Appropriations  to  railway  reserve,  854. 

Approximate  synchronism  of  stock  and 
bond  price  movements,   1436. 

Arkansas  in  default,  397. 

Arrearage  bonds,,  nature  of,  306. 

533 


Assessed  valuation,  of  cities  and  towns, 
546-556;  of  counties,  473,  475;  of 
states,  433-438;  of  tax  districts,  727. 

Assessment  of  stock  as  affecting  secur- 
ity of  principal,  65. 

Assignment  of  street  railway  fran- 
chises, 1034. 

Assumed  bonds,  legal  position,  209. 

Assumed  guaranties,  205. 

Atchison,  Topeka,  and  Santa  Fe,  Ad- 
justment 4s  of  1995,  321;  equip- 
ments  in   receivership,   937. 

Atlanta,  Birmingham,  and  Atlantic 
equipments  in  receivership,  958. 

Attitude  of  the  states  toward  their 
present   debts,  412   et  seq. 

Attorneys  for  bond  houses,  649,  681. 

Aurora,  Elgin  and  Chicago,  1017,  1038. 

Austin,  Tex.,  Refunding  bonds  of 
1931,  339. 

"  Average  maturity "  of  serial  issues 
in  relation  to  their  cost,  1365,   1366. 

Bangor  and  Aroostook,  analysis  of 
freight  traffic,  768,  769. 

Balance  sheet  of  railroads,  863,  875- 
890. 

Balloting,  irregularity  in,  the  cause  of 
illegality  in  municipal  issues,  656. 

Baltimore  and  Ohio,  equipments  in  re- 
ceivership, 940 ;  Pittsburg,  Lake  Erie, 
and  West  Virginia  4s,  138. 

Bank  clearings  in  relation  to  national 
development   (with  chart),  1423. 

Bank  deposits,  as  demand  loans,  99; 
convertibility  of,  43. 

Bank  discount  in  bond  transactions, 
1314-1321. 

Bank  statements  as  an  index  of  credit, 
444. 

Bank  stocks,  New  England,  marketa- 
bility of,   170. 

Banking  and  currency  measures,  effect 
of,  on  prices  of  United  States  bonds, 
366-367. 

Banking  attitude  toward  listed  and 
unlisted  bonds,  166,  167. 

Banking  function  of  the  bond  houses, 
1576,  1577. 


534 


INDEX 


(The  references  are  to 

Banknote  circulation,  basis  of,   1545. 

Banknotes,  nature  of,   1589. 

Bankruptcy  of  railroads,  mortgage 
priority  in,  894-897. 

Baring  Bros.'  inquiry  of  Daniel  Web- 
ster, 410. 

Basis  of  assessed  valuation  for  cities 
and  towns,  548;  of  investment  value, 
as  income,  1374-1376;  of  municipal 
debt   limitation,   634. 

Bearing  of  speculation  upon  investment 
security,    1400-1403. 

Bibliography  of  railroad  bonds,  746, 
note. 

Birmingham,  Ala.,  financial  difficulties, 
542. 

Blanket  mortgage  steamship  bonds, 
970. 

Blanket  railroad  mortgages  in  relation 
to  equipment  obligations,  903. 

Bond  attorneys,  649,  681. 

Bond  business,  the,  1562  et  seq. ;  as  a 
science,  13-15;  the  financing  of  the, 
1455. 

Bond  buying,  11. 

Bond  default,  see  Default,  Repudia- 
tion, etc. 

Bond,  definition  of,  186. 

Bond  Houses,  The,  Chap.  XL,  1562 
et  seq.;  as  an  investment  exchange, 
170-172;  as  fiscal  agents,  for  states 
and  municipalities,  1578;  for  cor- 
porations, 1579;  as  protectors  of 
interest  payments,  129;  the  chief 
selling  function  of   the,   62. 

Bond  issues  of  one  fixed  duration,  in 
reference  to  the  use  of  the  bond 
tables,   1331   et  seq. 

Bond  prices,  charted,  1429,  1430;  in 
relation  to  commodity  prices,  1558- 
1561;  in  Relation  to  the  Trade 
Cycles,  Chap.  XXXVIII,  1431  et 
seq. ;  movements  slightly  anticipate 
stock  movements,  1437;  recovery 
after  a  panic,  1448-1449;  the  two 
general  factors  in  the  advance  of, 
1425. 

Bond  recital,  the,  in  relation  to  the 
estoppel,  679. 

Bond  security,  railroad,  as  affected  by 
priority  of  claim,  891-897. 

Bond  selling,  10. 

Bond  tables  (see  also  Extended  bond 
tables )  ;  The  Use  of,  Chap.  XXXV, 
1322  et  seq.;  miscellaneous,  1373. 

Bonds,  hypothecary  value  of,  48;  his- 
tory of,  4,  5;  of  optional  duration, 
1369-1372;  of  Tax  Districts,  Chap. 
XIX,  711  et  seq.;  versus  Mortgages, 
Chap.  VI,  112  et  seq. 


section  numbers) 

Bonus  bonds,  nature  of,  290. 

Book  value  in  the  accountancy  of  in- 
vest ments,    1377. 

Boston  Terminal  3y2s,  259. 

Bridge   bonds,  nature  of,  256. 

British  consols,  353. 

British   railroad  credit,  804. 

Brooklyn  bonds  have  prior  claim  on 
Brooklyn  taxes,  57J. 

Buffalo,  N.  Y.,  good  credit,  689. 

Buffalo  and  Susquehanna  equipments 
in  receivership,  959. 

Buffalo,  Lockport,  and  Rochester,  1014. 

BufFalo,  Rochester,   and  Eastern,   1014. 

Buncombe   County,  N.   C,   500. 

Business  and  per  capita  wealth  (with 
charts),   1420-1428. 

Business   cycle,   the,    1442  et  seq. 

Butte,  Mont.,  School  District  No.  1, 
742. 

Buying  bonds,  1. 

Cabell  Co.   (W.  Va.)   Court  House  and 

Bridge  bonds,  342,  note. 
Cairo,  111.,  in  default,  686. 
Call    loans    (see    Demand    loans),   uses 

and  rates,  93. 
Callable  bonds,  342-344;    625-629;   how 

to   compute   the   price   and  net  yield 

of,  1369-1372. 
Canada,  see  the  provinces  by  name. 
Canadian     Pacific     Land     Grant     3y2s, 

249. 
Canadian  Power  Co.,  competition,  1116. 
Canadian    provinces     requiring    special 

legislative     sanction     for     municipal 

debt  incurrence,  645. 
Canadian   restrictions  on   the   duration 

of  municipal  debt,  667. 
Canadian      specific      municipal      bond 

taxes,  535. 
Canadian      validation      of      municipal 

issues,  676. 
Cape  Girardeau,  Mo.,  in  default,  686. 
Capital    Account    of    Railways,    Chap. 

XXI,  855  et  seq. 
Capitalization    and    earnings   of    water 

companies,   1089,   1090. 
Capitalization,  in   the  railroad  balance 

sheet,     881-890;     of     street     railway 

companies,    1022-1026. 
Car  trust  association  stock,  910-912. 
Car    trust    bonds,    distinguished    from 

car  trust  certificates  and  equipment 

bonds,  913. 
Car   trust  certificates,   908-912;    defini- 
tion of,  223. 
(  a  rev    Act    irrigation    projects,    1225- 

1241. 
Carload,  the,  780. 


INDEX 


535 


(The  references  are  to  section  numbers) 


Cash,  meaning  of,  1588  et  seq. 

Cash  surrender  bonds,  346,  347. 

Cass  County,  Ind.,  bonds,  480. 

Certification  of  validity  of  municipal 
bonds  by  states,  670-676. 

Central  Railroad  and  Banking  Co.  of 
Georgia  equipments  in  reorganiza- 
tion, 934. 

Certificates,  of  beneficial  interest,  na- 
ture of,  229;  of  indebtedness,  nature 
of,  188. 

Certification  and  supervision  of  muni- 
cipal issues  by  trust  companies,  669. 

Channels  of  Investment,  The,  Chap.  V, 
87  et  seq. 

Character  of  traffic  in  railroad  analy- 
sis,  768-770. 

Charlestown  Real  Estate  4s,  248. 

Chart  Table,  see  List  of  Charts,  p.  xv. 

Chart,  of  the  curves  of  investment 
value,  1387;  of  the  equity  in  serial 
(equipment)  bonds,  962;  of  business 
and  per  capita  wealth,  1420-1428; 
of  national  development  and  re- 
sources, 1414  et  seq.;  of  population 
and  production,  1415-1419;  of  secur- 
ity prices,  1429-1430. 

Charter  bonds,  nature  of,  291. 

Chattel  mortgages  in  relation  to  equip- 
ment obligations,  904,  905. 

Chesapeake  and  Ohio  equipments  in 
reorganization,  933. 

Chicago  and  Alton  First  Lien  3%s  of 
1950,  260 ;  Refunding  3s  of  19Jt9,  260. 

Chicago  and  Eastern  Illinois  Refund- 
ing 4s,  market  for,   171. 

Chicago  and  Northwestern  Sinking 
Fund  5  s  and  6s  of  1929,  101. 

Chicago,  Burlington,  and  Quincy,  Illi- 
nois Division  3y3s,  market  for,  171; 
sinking  funds,  839. 

Chicago,  Cincinnati,  and  Louisville 
equipments  in  receivership,  950. 

Chicago,  City  of,  World's  Fair  bonds, 
608. 

Chicago  City  Railway  fares,  1032; 
franchises,  1028;  First  5s  as  redeem- 
able bonds,  1369,  note. 

Chicago,  Milwaukee,  and  St.  Paul 
Debenture  4s,  protection  for,  187; 
Terminal  5s  of  1914,  259. 

Chicago  Sanitary  District,  743. 

Chicago  Southern  equipments  in  re- 
ceivership, 956. 

Chicago  Terminal  Transfer  4s,  259. 

Cincinnati,  Hamilton,  and  Dayton 
equipments   in  receivership,  947. 

Circulation,  bank,  see  the  entire  Ap- 
pendix, 1587  et  seq.;  equation  of 
profit   or   loss   on,    1595   et   seq.;    of 


banknotes,  basis  of,  1545;  of  un- 
covered paper  in  the  world  in  1907, 
1543;  per  capita  in  relation  to  na- 
tional development  (with  chart), 
1421,  1422;  inelasticity  of,  a  me- 
chanical source  of  panics,  1547;  in 
relation  to  interest  rates,  1598  et 
seq.;  tax  on  national  bank  circula- 
tion, 1594;  velocity  of,  1498  et  seq.; 
1521,  1522. 

City  and  Town  Bonds:  Municipal 
Assets,  Chap.  XVI,  512  et  seq.;  Mu- 
nicipal Liabilities,  Chap.  XVII,  590 
et  seq.;  Validity  and  Good  Faith, 
Chap.  XVIII,  647  et  seq. 

City  statement,  the,  518. 

Civil  loans,  nature  of,  179;  in  the 
classification   table,   183. 

Class  legislation  in  relation  to  legality 
of  municipal  issues,  656. 

Classes  of  cities,  516. 

Classification  ajid  Description  of 
Bonds:  According  to  the  Character 
of  the  Obligor,  Chap.  VIII,  176  et 
seq.;  table  of,  178;  According  to  the 
Security  for  the  Bonds,  Chap.  IX, 
183  et  seq.;  According  to  the  Pur- 
pose or  Function  of  the  Issue,  Chap. 
X,  288  et  seq.;  According  to  Con- 
ditions Attending  Payment  of  In- 
terest or  Principal,  Chap.  XI,  318 
et  seq. 

Classification  of  investment,  by  the 
nature  of  the  interest,  89 ;  by  the 
contract  of   redemption,   90-111. 

Clearings  in  relation  to  national  de- 
velopment   (with   chart),   1423. 

Coextensive  cities  and  counties,  510. 

Coextension  of  political  divisions  as 
affecting  the  debt  limit,  598-600;  of 
tax  districts  and  towns,  566. 

Coinage,  proportion  of  world's  gold 
that  is  coined,  1506. 

Collateral,  see  Hypothecation,  etc. 

Collateral  income  bonds,  nature  of, 
228. 

Collateral,  investments  as,  46-48. 

Collateral  mortgage,  bonds,  nature  of, 
224;   notes,   223. 

Collateral  or  hypothecary  value  as  a 
price  factor  of  municipals,  698. 

Collateral  security,  see  also  Paper  col- 
lateral security. 

Collateral  trust  bonds,  nature  of,  217 
et  seq. 

Colorado  and  Southern  acquired  by  the 
Chicago,  Burlington,  and  Quincy, 
780. 

Columbus  and  Hocking  Coal  and  Iron 
First  5s,  119. 


530 


INDEX 


(The  references  are  to  section  numbers) 


Columbus,  Hocking  Valley,  and  Toledo 
equipments  in  receivership,  944. 

Commercial  and  Financial  Chronicle, 
Railway  and  Industrial  supplements, 
759. 

Commercial  drafts,  97. 

Commissions,  listed  versus  unlisted 
bonds,    172. 

Commodities,  definition  of,  1496;  in 
the  price  equation,   1523  et  seq. 

Commodity  prices,  in  relation  to  bond 
prices,  1558-1561;,  conclusion  as  to 
future  of,  1553. 

Community  of  railroad  interest,  754, 
755. 

Company,  distinguished  from  corpora- 
tion  in   England,   179,   note. 

Comparisons  of  assessed  valuations  of 
cities  and  towns,  549-553;  of  county 
debt,  481 ;  of  municipal  tax  rates, 
525-531 ;  of  state  valuations,  437. 

Competition  in  respect  to  water  power 
supply,  1116,  1117;  in  water  supply, 
1081 ;  of  interurbans  and  railroads, 
1003-1006;  of  oil  and  electricity  with 
gas,   1042-1047. 

Components  of  assessed  valuation,  438; 
in  cities  and  towns,  544. 

Compromise  bonds,   665. 

Conclusion  as  to  the  future  of  com- 
modity prices,   1553. 

Conditional  sale  plan  of  purchasing 
railroad  equipment,  906-907;  in 
Pennsylvania,  914-917. 

Conditions  affecting  the  supply  of 
water  powrer,  1107-1112;  the  water 
power  demand,  1113  et  seq.;  the 
drinking  water  supply,  1071;  the 
drinking  water  demand,    1082,    1083. 

Connecticut,  history  of  her  early  debt, 
384;  the  recording  of  equipment 
mortgages  in,   905. 

Consolidated  mortgage  bonds,  nature 
of,  270,  277. 

Consolidated  railroad  mortgages  in  re- 
lation to  equipment  obligations,  903. 

Consols,  353. 

Constitutional  debt  restrictions,  413. 

Constitutional  law  and  state  debt,  371- 
376. 

Construction  bonds,  nature  of,  292. 

Construction  estimates  for  water 
powers,  1112. 

Contingent  debt,  of  cities  and  towns, 
594,  595;  of  counties,  480,  482. 

Continued  bonds,  nature  of,  293. 

Contracts  and  franchises  of  water  com- 
panies,  1092-1097. 

Contracts  of  water  power  companies 
with  consumers,  1118. 


Control,  proprietorship,  and  manage- 
ment of  railroads,  750-756. 

Convertible  collateral  trust  bonds,  na- 
ture of,  221. 

Convertible  issues,  nature  of,  348- 
352. 

Convertibility  (see  Marketability),  na- 
ture of,  41-45;  aided  by  speculation, 
44;  as  affected  by  denomination, 
152;   of  bank  deposits,  43. 

Corporate  debentures  in  the  classifica- 
tion table,  183. 

Corporate  stock,  36,  Note  3. 

Corporation  bond  buying  by  the  bond 
houses,    1571. 

Corporation  loans,  nature  of,  in  Eng- 
land  and  America,    179. 

Corporation  notes,  nature  of,   190. 

Corporation  stock  in  England,  nature 
of,  188. 

Cost  (see  also  Price),  of  bonds,  1380; 
of  gas,   1045. 

County  Bonds,  Chap.  XV,  463  et  seq. 

County  debt,  477-484. 

County  repudiation,  497-505. 

Coupon  bonds,  nature  of,  325. 

Credit  balances  as  demand  loans,  92. 

Credit,  meaning  of,   1588  et  seq. 

Criminality  in  relation  to  municipal 
loans,  668. 

Cuba,  see  Republic  of  Cuba. 

Cumulative  income  bonds,  320. 

Currency  bonds,  332. 

Current  assets  in  the  railroad  balance 
sheet,   880. 

Current  expense  bonds,  665. 

Current   versus   uncurrent   bonds,    164. 

Curve  of  bond  prices  in  elevation  and 
depression,  1459-1466. 

Curves  of  Investment  Value,  chart  of, 
1387. 

Cycles  of  trade,  1442  et  seq. 

Debenture  income  bonds  (see  also  In- 
come bonds),   191-194. 

Debenture  mortgage  bonds,  286. 

Debenture  stock  in  England,  nature  of, 
188. 

Debentures,  in  default,  legal  remedies 
of  bondholders,  187;  in  the  classifi- 
cation table,  183;  nature  of,  184- 
187. 

Debt  limitations  and  restrictions,  city 
and  town  bonds,  629-640;  of  counties, 
484;  New  York  City,  612;  as  affect- 
ing validity  666;  in  state  constitu- 
tions, 413. 

Debt  (see  also  Net  debt,  Real  net  debt, 
Legal  net  debt,  General  debt,  etc.) 
of  cities  and  towns,  590  et  seq. 


INDEX 


537 


(The  references  are  to  section  numbers) 


Decimal  approximation  as  a  source  of 
inaccuracy  in  the  bond  tables,   1290. 

Decline  in  gas  rates,   1059,   1060. 

Deductions  from  gross  corporate  in- 
come of  railroads,  831-840. 

Deepwater  Tidewater  Railway  bonds  as 
notes,   190. 

Deer  Lodge  County,  Mont.,  498. 

Default  and  repudiation,  the  distinc- 
tion between,  400;  of  state  debts, 
377  et  seq. 

Default,  American  bond,  as  borne  by 
Europe,  12;  freedom  from  care  in, 
bonds  versus  mortgages,  149;  of 
debentures,  legal  remedies  of  bond- 
holders, 187;  on  guaranteed  bonds 
versus  default  on  debentures,  208; 
on  municipal  bonds  does  not  mature 
the  principal,  36;  on  municipal 
mortgage  bonds  usually  entails  fore- 
closure, 578;  on  "specialties,"  atti- 
tude of  the  bond  houses  toward, 
1586. 

Deferred  bonds,   nature  of,   339. 

Deficiency   bonds,    665. 

Degree  of  municipal  debt  limitation, 
635. 

Delaware  and  Hudson,  equipment  loan 
due,  1922,  964;  trollev  purchases, 
1014. 

Delaware,  history  of  her  debt,  385. 

Delinquent  tax  certificates,  nature  of, 
294. 

Demand   loans    (see   Call   loans),  91. 

Demonetization  of  silver  in  various  na- 
tions, 1486. 

Denomination,  as  affecting  income,  55; 
as  an  investment  quality,  53-55; 
bonds  vs.  mortgages,  151,  152;  of 
real  estate  mortgage  bonds,  1144; 
stocks  versus  bonds,   83. 

Density  of  traffic,  777,  778. 

Denver  and  Rio  Grande  equipments  in 
foreclosure   and    reorganization,   932. 

Deposits,  see  Bank  deposits. 

Depreciation,  of  gold  as  a  check  upon 
its  production,  1548;  of  rolling 
stock  and  serial  payment  of  the 
equipment  bonds,   960-963. 

Depredationists,  their  argument,  1529. 

Derivation  of  the  bond  formulas,  1293 
et  seq. 

Desert  Land  Act,  1203. 

Detroit,  Toledo,  and  Ironton,  Ann 
Arbor  Collateral  Trust  Notes,  220; 
equipments  in   receivership,   949. 

Development  of  national  resources, 
1412  et  seq. 

Difference  between  discount  price  and 
basis  price  for  bonds,  1318-1321. 


Difficulties  of  studies  in  bond  prices, 
1404-1410. 

Dillon,  Judge,  on  the  mortgage  claim 
of  the  municipal  bonds  of  New  Eng- 
land, 573. 

Disadvantages  of  irrigation  bonds, 
1238-1240. 

Discount  and  premium  as  affecting  ap- 
preciation, 58. 

Discount  bonds,  nature  of,  176,  332. 

Discount,  nature  of,  1271. 

Discounting  bonds,  1314-1321;  having 
two  or  more  coupons  attached:  i.e., 
running  over  six  months,  1320,  1321. 

Disincorporation  of  municipalities  for 
the  purpose  of  repudiation,  687. 

Disposal  of  net  corporate  railway  in- 
come or  surplus,  850-854. 

Distinction  between  steam  and  electric 
securities,  1016,  1017. 

Distribution,  of  municipal  issues  as  a 
price  factor,  695 ;  of  money  and  com- 
modities, 1533-1537;  of  risk  applied 
to  state  and  municipal  bond  security, 
456,  note;  of  risk  as  affected  by 
security   denomination,   152. 

District  debt,  733. 

District  statement,  the,  719. 

District  tax,  719-721. 

Dividend  and  interest  disbursements  of 
street  railway  companies,  1024. 

Dividend  bonds,  nature  of,   332. 

Dividend  yield,  the  factors  determin- 
ing, 1268  et  seq. 

Dividends,  mathematical  qualities  of, 
1255-1260;  on  American  railroad 
stocks,  35,  note. 

Divisional  bonds,  nature  of,  252;  versus 
"parent  company"  bonds,  216. 

Dock  bonds,  nature  of,  257. 

Drainage  area  for  water  power  supply, 
1108. 

Drainage  bonds,  classified,  295;  nature 
of,   1242  et  seq. 

Drainage  districts,  716. 

Duluth,  Minn.,  in  default,  686,  740. 

Duration  (see  also  Serial  bonds),  and 
appreciation  of  real  estate  deben- 
tures, 1136;  as  a  factor  of  net  yield, 
1273;  as  a  factor  of  safety  to  bene- 
ficiaries, 124;  as  affecting  price 
fluctuation,  1407-1410;  as  an  invest- 
ment quality,  52;  bonds  versus 
mortgages,  150;  computed  for  bonds 
redeemable  at  a  premium,  1372; 
computed  for  bonds  redeemable  at 
par,  1371 ;  of  interest  interval,  effect 
on  bond  prices,  1357-1361;  of  loans 
as  affecting  current  value,  33 ;  of 
municipal  loans,  667;  of  street  rail- 


:,;;s 


INDEX 


(The  references  are  to  section  numbers) 


way     franchises,     1028-1031;     stocks 
versus  bonds,  82. 

Earlv  weaknesses  of  irrigation  bonds, 
1190-1200. 

Earning  Power  and  the  Income  Ac- 
count of  Railroads,  Chap.  XXI,  783 
et  seq. 

Earnings,  of  gas  companies  as  affected 
by  hard  times,  1007 ;  of  steamboats 
in  relation  to  the  bonds,  987-990;  of 
water    companies,    1089,    1090. 

Eastern  interurban  development:  sat- 
urative,  1007-1014. 

Economic  development  of  the  gas  in- 
dustry,  1047-1052. 

Economic  function  of  the  county,  the, 
467. 

Effect  of  hard  times  on  gas  companies, 
1067. 

Electric  railway  bonds,  see  Street  rail- 
way bonds. 

Electrification  of  steam  roads,  1015. 

Elements  of  successful  operation  in  the 
gas   industry.    1053-1064. 

Eleventh  Amendment  and  state  debt, 
373. 

Eligibility  of  leasehold  mortgage  bonds 
for  national  banks,  1151. 

English  railroad  credit,  804. 

Equal  annual  instalment  bonds,  337. 

Equal  instalment  bonds,  337. 

Equalized  valuation  of  states,  434. 

Equation,  of  price,  1493  et  seq.;  of 
profit  or  loss  on  circulation,  1595 
et  seq. 

Equilibrating  action  of  interest  rates, 
1561. 

Equipment  bonds  or  notes,  chart  of 
the  equity  in,  962;  definition  of,  234; 
distinguished  from  car  trust  certifi- 
cates and  car  trust  bonds,  918- 
922. 

Equipment   mortgage   statutes,   921. 

Equipment  of  railroads,  character  and 
condition  of,  in  railroad  analysis, 
771-774. 

Equipment  Trust  Obligations,  Chap. 
XXIII,  899  et  seq.;  see  also  Equip- 
ment bonds,  etc. 

Equities   for   steamship   bonds,  971. 

Equity,  in  American  real  estate  mort- 
gages, 116;  in  serial  (equipment) 
bonds,   chart  of,   962. 

Erie  Railroad,  common  stock,  158; 
efficiency,  traffic,  and  securities,  855; 
First  Consolidated  Prior  Lien  4s, 
261;  sinking  funds,  837. 

Escanaba  (Mich.)  Waterworks  Co. 
bonds,  default  of  principal,   1099. 


list i mates,  of  construction  for  water 
power,  1112;  of  population,  583. 

Estoppel   and   the  bond  recital,  679. 

Etymology,  the  development  of  per- 
sonal property  as  indicated  by,  3. 

Evasion  of  the  municipal  debt  limit, 
646. 

Exemption,  from  care  as  an  investment 
virtue,  51;  from  tax,  as  an  invest- 
ment virtue,  49. 

Express  companies,  classification  of,  by 
the  Interstate  Commerce  Commis- 
sion, 180. 

Extended  bond  tables  for  schedules  of 
amortization  and  accumulation,  1392. 

Extended  bonds,  nature  of,  293,  340. 

Extension  bonds,  nature  of,  253. 

External   loans,  nature  of,  176. 

Extravagance  as  a  cause  of  high  prices, 
1550. 

Factor  of  Safety,   841-849. 

Factors  of  net  return,  1268  et  seq. 

Fair  Income  Return,  nature  of,  38-40. 

Farm  mortgage  bonds,  nature  of,  250. 

Federal   irrigation,    1201-1207. 

Ferry  bonds,  nature  of,  257. 

Fifteen  year  charts,  the,  how  con- 
structed, 1433,  1434. 

Fifty  Year  Course  of  Bond  Prices, 
Chap.  XXXVII,  1400  et  seq. 

Financial  competency  in  relation  to 
municipal  loans,  515  et  seq. 

Financial  Graphic  Co.'s  charts,  1433. 

Financial  history  of  equipment  trust 
obligations,  930  et  seq. 

Financing  methods  of  street  railways, 
1026,   1027. 

Fire  hazard,  in  relation  to  timber 
bonds,   1179-1182. 

First  and  consolidated  mortgage  bonds, 
nature  of,  272. 

First  and  refunding  mortgage  bonds, 
nature   of,    267. 

First  bond  formula,  derivation  of,  1295- 
1311. 

First  consolidated  mortgage  bonds,  na- 
ture of,  273. 

First  general  mortgage  bonds,  nature 
of,  276. 

First  lien  and  general  mortgage  bonds, 
nature  of,  275. 

First  mortgage  bonds,  nature  of,  264. 

First  mortgage  trust  bonds,  227. 

First  refunding  mortgage  bonds,  na- 
ture of,  266. 

First  Repudiation  Period,  388-394. 

Fiscal  agents,  bond  houses  as,  for  states 
and  municipalities,  1578;  for  corpo- 
rations, 1579. 


INDEX 


539 


(The  references  are  to  section  numbers) 


Fixed  charges  of  railroads,  831-840. 
Fixity  of  interest  or  income,  34-37. 
"Flat"     price     for    bonds,     1325-1327, 

1330. 
Floating    debt,    as    affecting    legal    net 

debt,   605,   606;   of  cities  and  towns, 

591,  592. 
Florida,    default    on    state    debt,    388, 

394,  397,  403,  410. 
Foreclosure,    by    railroad    bondholders, 

894-897;    in    default   of    interest    on 

municipal    mortgage   bonds,    578;    of 

waterworks  bonds,   1097,  1098. 
Foreign  trade   as  a  factor  in  national 

development  (with  chart),  1421. 
Formulas    for    deriving    bond    values, 

1293   et  seq. 
Founders'  bonds,  nature  of,  296. 
Fourteenth  amendment  and  state  debt, 

372,  note. 
Franchises,    of    street    railways,    1028- 

1034;     of    water     companies,     1092- 

1097. 
Free  rental  value  of  money,  39,  40. 
Freedom  from  care,  as  an  investment 

virtue    (see   Exemption    from    care), 

51;     bonds    versus    mortgages,     147- 

149;  stocks  versus  bonds,  81. 
Freight  density,  777,  778. 
Freight   trainload,   781,   782. 
French   rentes,   353. 
Fuel  gas,  1048,  1049. 
Functions  of  the  bond  houses,  1566  et 

seq. 
Funding  bonds,   nature  of,   297. 
Future  amount  of  a  present  sum,  how 

found,   1298,  1299. 
Future,  of  Bond  Prices,  Chap.  XXXIX, 

1476   et   seq.;    of    commodity   prices, 

conclusion  as  to,   1553;   of  irrigation 

bonds,    1241;    of   levee   and   drainage 

district  bonds,   1251,   1252. 

Galveston,  Tex.,  good  faith  and  ad- 
justment of  debt,  687. 

Gamble  in  "  Governments "  by  Na- 
tional Banks,  The,  Appendix,  1587 
et  seq. 

Gambling,  Speculation,  and  Investment, 
Chap.  II,  17  et  seq. 

Gambling,   nature  of,    19. 

Gas  Company  Bonds,  Chap.  XXVI,  1041 
et  seq. 

Gas  bonds  as  high  grade  securities, 
1065-1069. 

Gas  companies  not  public  service  cor- 
porations, 1068. 

Gas  engines,  development  of,  1049. 

Gas  rates,  relation  of,  to  population. 
1055. 


General  and  first  mortgage  bonds,  na- 
ture of,  275. 

General  first  mortgage  bonds,  nature 
of,  275. 

General  mortgage  bonds,  nature  of, 
274,  277. 

General   tax,   states   without,   429. 

Georgia  Pacific  equipments  in  reor- 
ganization, 934. 

Georgia,  State  of,  certification  of  the 
validity  of  municipal  issues,  672;  in 
default,  397;  sued  by  a  citizen  of 
North  Carolina,  373. 

Gillette,  Col.,  in  default,  690. 

Gold  bonds,  332,  333. 

Gold  depredationists,  their  argument, 
1529. 

Gold,  in  proportion  to  the  world's 
credit  currency,  1515-1516;  in  pro- 
portion to  the  world's  "  money 
proper"  stock,  1512-1514;  in  propor- 
tion to  the  world's  total  metallic 
money,  1507 ;  in  the  price  equation, 
1502-1520;  increasing  annual  output 
of  (with  chart),  14S2  et  seq.;  pro- 
duction checked  by  gold  depreciation, 
1548;  supply  in  effect  upon  security 
in  liquidation,   1403. 

Good  faith,  as  a  factor  of  municipal 
security,  682-688;  of  counties,  496- 
505  of  tax  districts,  738. 

Government  bonds  (see  also  United 
States  bonds ) ,  in  the  classification 
table,  178;  income  from,  39;  The 
Gamble  in  "  Governments "  by  Na- 
tional Banks,  Appendix,  1587  et 
seq. 

Grading  of  municipalities  by  popula- 
tion, 516. 

Grand  list,  the,  546. 

Green  County,  Ky.,  504. 

Greenbacks  as  demand  loans,  92. 

Gross  corporate  income  of  railroads, 
830. 

Guaranteed  bonds,  nature  of,  202-208; 
versus  debentures,  relative  legal  po- 
sition in  default,  208. 

Guaranteed  mortgages,  121-123. 

Guaranteed  stocks  in  relation  to  fixity 
of  income,  36. 

Guaranty  as  affecting  security,  bonds 
versus  mortgages,  121-124;  of  equip- 
ment obligations  by  railroads,  909; 
of  principal  distinguished  from  guar- 
anty of  interest,  206,  207;  joint,  210. 

Guaranty  security,  nature  of,  197,  198; 
table  of  bonds  classified  under,  183. 

Hallett's  decision  on  priority  of  equip- 
ment payments,  924. 


540 


INDEX 


(The  references  are  to  section  numbers) 


Hartford,  Conn.,  high  credit  of,  689. 

Heinz's  table  of  commodity  prices, 
1535. 

Helena,   Ark.,   in   default,   686. 

Helena,  Mont.,  illegal  warrants,  687. 

Henderson  County,  N.  C,  repudiation, 
503. 

Hereditary   tendencies    in   finance,   404. 

High   rate  bonds,   329. 

High  yield  bonds,   330. 

Hinsdale  County,  Col.,  504. 

Hire  of  railroad  equipment,  794. 

History,  of  bonds,  4,  5;  of  equipment 
trust  obligations  in  reorganization 
and  foreclosure,  930  et  seq. ;  of  state 
debt,  370  et  seq.;  of  street  railway 
traffic,  995  et  seq.;  of  the  national 
debt,  357. 

Holding  companies  for  gas  concerns, 
1068. 

Homestead  law,   1202. 

Houston,  Tex.,  in  default,  686. 

Hudson  and  Manhattan  Company  First 
Mortgage  4y2s,   221. 

Hudson  Companies  Convertible  (col- 
lateral)  6s  of  1910  and  1911,  221. 

Hydro-electric  power  bonds  as  a  de- 
scriptive title,   1102. 

Hypothecation  (see  Collateral,  etc.)  of 
bonds  by  the  issuing  company,  and 
the  legal  effect  on  the  bonds  when 
sold,  315. 

Hypothecary  or  collateral  value  as  a 
price  factor  of  municipals,  698; 
bonds  versus  mortgages,  143,  144; 
listed  versus  unlisted  securities,  79; 
of  investments,  46-48;  stocks  versus 
bonds,  79. 

Ideal  Investment,  The  Elements  of  an, 
Chap.  Ill,  30. 

Illegality  (see  Invalidity)  ;  the  cause 
of  the  rejection  of  $4,000,000  of  civil 
loan3  in  1907,  653;  the  causes  of, 
654. 

Illinois,  default  on  state  debt,  388;  re- 
pudiation of  railroad  aid  bonds,  659; 
special  assessment  drainage  district 
bonds,  731. 

Implied  power  of  taxation,  for  special 
assessment  bonds,  723;  to  support 
municipal   loans,   539-540. 

Importance,  of  modern  gas  manage- 
ment, 1064;  of  size  and  population 
served,  in  the  gas  business,  1054- 
1057;  of  the  gas  industry,  1041;  to 
street  railways  of  territory  served, 
1036-1038. 

Improved  Property  Holding  Co.,  New 
York,  6s,  1269,  note;   1310. 


Improvement  bonds,  nature  of,  298; 
.^ninetimes  special  assessment  bonds, 
724. 

Improvement  mortgage  bonds,  nature 
of,  284,  285. 

Inaccuracies  in  the  determination  of 
the  bond  tables,   1283-1292. 

Incidence  of  the  mortgage,  table  of 
bonds   classified   under,    183. 

Income  Account  of  Railroads,  Chap. 
XXI,  783  et  seq.;    items  of,  786. 

Income,  as  affected  by  "artificial" 
market  conditions,  38 ;  as  affected  by 
denomination,  55;  as  affected  by  tax- 
ation, 49,  50;  as  the  basis  of  invest- 
ment value,  1374-1376. 

Income  bonds,  320. 

Income  from  mortgages  diminished  by 
fees,   136. 

Income  ratio  of  railroads,  886-888,  890. 

Income  return,  bonds  versus  mortgages, 
133-141;  stocks  versus  bonds,  74; 
American  railroad  and  industrial 
stocks,  75;   urban  real  estate,   135. 

Increasing  annual  output  of  gold  (with 
chart),   1482  et  seq. 

Indexes  of  commodity  prices,  1535. 

Indiana,  default  on  state  debt,  388. 

Indianapolis  School  District  bonds,  744. 

Indorsed  bonds,  nature  of,   198,   199. 

Industrial  and  miscellaneous  bonds  in 
the   classification   table,    178. 

Industrial  stocks,  American,  average 
return  from,  75. 

Influence  of  the  bond  houses  on  Amer- 
ican  finance,    1574. 

Influences,  tending  toward  increase  in 
the  volume  of  commodities,  1549- 
1552;  toward  lower  prices,  1542;  to- 
ward the  absorption  of  the  gold 
supply,  1543. 

Instantaneous  reinvestment,  the  lack  of, 
as  a  source  of  inaccuracy  in  the 
bond  tables,  1288. 

Institutional  demand  as  a  price  factor 
of  municipals,  696. 

Insurance  and  rental,  as  factors  of  loan 
income,  39;  of  capital  as  components 
of  interest,   103,   104. 

Insurance  as  a  channel  of  investment, 
110. 

Insurance  contracts,  marketability  of, 
42;  hypothecary  value  of,  47. 

Insurance  demand  for  state  bonds,  457, 
458. 

Insurance  in  favor  of  steamship  blanket 
mortgage  bondholders,  973 ;  of  "  sin- 
gle boat"  bondholders,  985,  986. 

Interboro  Rapid  Transit  Co.  fares, 
1032. 


INDEX 


541 


(The  references  are  to  section  numbers) 


Intercepting  sewer  bonds,  308. 

Interchangeable  bonds,  326. 

Interest  and  dividend  disbursements  of 
street  railway  companies,  1024. 

Interest  as  rental  plus  insurance  of 
capital,  103,  104. 

Interest  interval  as  a  factor  of  net 
yield,   1273. 

Interest  intervals,  irregular,  effect  on 
bond  prices,   1357-1361. 

Interest  on  American  railroad  bonds, 
35,  note. 

Interest  payments,  mathematical  quali- 
ties of,  1261  et  seq. ;  regularity  of, 
129. 

Interest  rate,  significance  of,  329,  482, 
628;  perpetuity  of,  130;  on  the  sink- 
ing fund,  1276-1282,  1284-1286,  1305- 
1309. 

Interest  rates,  equilibrating  action  of, 
1561 ;  in  relation  to  national  bank 
circulation,  1598  et  seq. 

Interest,  security  of  (see  also  Stability 
of  income),  34-37,  125-132,  1400- 
1403. 

Interim  certificates  and  bonds,  299, 
313. 

Interminable  loans,  see  Perpetual  loans. 

Internal   loans,  nature  of,   176. 

International  and  Great  Northern 
equipments  in  receivership,  951. 

Interpretation  of  the  schedules  of 
amortization  and  accumulation,  1382. 

Interstate  Commerce  Commission,  atti- 
tude on  railway  valuation,  858-874; 
reports,  758. 

Interurban,  centers,  998,  999;  railways, 
996-1014. 

Investment,  The  Channels  of,  Chap.  V, 
87  et  seq. 

Investment  value,  income  as  the  basis 
of,  1374-1376. 

Invalidity  (see  Illegality,  Validity, 
Legality)  ;   remedies  of,  668. 

Investment  capitalization  of  railroads, 
888. 

Investment  characteristics  of  street 
railway  bonds,   1039. 

Investment,  distinguished  from  specu- 
lation, 27-29;  nature  of,  23. 

Investment  principle  for  street  railway 
bonds  caveat  emptor,  1018  et  seq. 

Investment  return  of  equipment  obliga- 
tion, 966-968. 

Investment  value,  of  bonds,  1460;  of 
state  bonds,  456-460 

Investments,  as  loans,  31,  32;  classified 
by  the  contract  of  redemption,  90- 
111;  classified  by  the  nature  of  the 
interest,  89. 


Iowa's  excellent  financial  record,  392. 
Irredeemable  loans  (see  Perpetual  loans 

and  Interminable  loans),  345. 
Irregular  initial  and  terminal  interest 

periods,  effect  on  bond  prices,   1357- 

1361. 
Irrigation  bonds,   1195  et  seq.;   in  the 

classification   table,   178. 
Irrigation    District    bonds,    1210-1214; 

mortgage  security  for,  732. 

Jefferson    County,    Wash.,    default    in 

good  faith,  505. 
Jeffersonville,    Ind.,    refunding    of    an 

illegal    issue,   687. 
Jersey  City  sinking  fund  investments, 

615. 
Jevons'     tables     of  commodity     prices, 

1535. 
"  Joint  and  several  "  bonds,  212. 
Joint  bonds,  nature  of,  211,  212. 
Joint  facilities  in  the  railway  income 

account,  834. 
Jointly  guaranteed  bonds,  210.     • 
Judgment  bonds,  nature  of,  300. 
Junior  issues,  263. 

Kansas    City    and    Memphis    Railway 

and  Bridge  bonds,  256. 
Kansas     City,     Pittsburg,     and     Gulf 

equipments  in  receivership,  945. 
Keeler  on  the  quantity  theory,  1533. 
Keeping  of   Investment  Accounts,  The, 

Chap.  XXXVI,   1374  et  seq. 
Keokuk,  la.,  in  default,  686. 

Lackawanna  and  Wyoming  Valley  Rail- 
road, 1016. 

Laclede  Gas  Company  immune  from 
rate  regulation,  1068. 

Lake  County,  Col.,  504. 

Lake  Shore  Railroad,  First  Mortgage 
3%9,  market  for,  171;  in  interurban 
competition,  1003. 

Lake  Street  Elevated  5s,  market  for, 
174. 

Land  and  water  rights  and  the  law, 
in  relation  to  irrigation  bonds,  1198- 
1200. 

Land  grant  bonds,  nature  of,  249. 

Land  title,  for  private  irrigation  pro- 
jects, 1223;  in  Carey  Act  irrigation 
projects,   1233,   1234. 

Latah  County,  Idaho,  489. 

Lawrence  County,  S.  D.,  default  in  good 
faith,   505. 

Lawrence,  Kas.,  in  default,  686. 

Lease  and  lease  warrants  in  relation 
to  car  trust  certificates,  908-912. 

Leasehold   mortgage    bonds,    1147-1151. 


542 


INDEX 


(The  references  are  to  section  numbers) 


Leavenworth,  Kas.,  in  default,  686. 

Legal  history  of  equipment  trust  obli- 
gations, 902-929. 

Legal  net  debt  of  cities  and  towns, 
601-612. 

Legal  opinion  of  a  Chicago  firm  as  to 
the  tax-exemption  of  territorial  mu- 
nicipals, 700. 

Legal  principles  of  the  mercantile  ma- 
rine applying  to  steamship  bonds,  976. 

Legal  tender  bonds,  332. 

Legality  (see  also  Validity),  of  muni- 
cipal obligations,  647-681;  of  muni- 
cipals guaranteed  by  Texas,  453. 

Legislative  sanction  required  for  muni- 
cipal   debt   incurrence,    645. 

Levee  bonds,   1242  et  seq. 

Levee   districts,   716. 

Liabilities  of  states  that  offset  wealth 
in  credit,  445. 

Lien,  on  personalty,  nature  of,  216; 
on  realty,  nature  of,  245. 

Lien  security,  nature  of,  213-215;  table 
of  bonds  classified  under,  183. 

Life  of  loans,  see  Duration. 

Listed  bonds,  and  marketability,  41 ; 
the  number  of  transactions  in  (1910), 
160;  true  market  for, — not  on  the  ex- 
changes, 171;  used  in  the  charts,  ta- 
bles of  the,  1470,  1477;  of  states,  158. 

Listed  quotations,  unreliability  of,  173, 
174. 

Listed  versus  Unlisted  Bonds,  Chap. 
VII,  156  et  seq. 

Listing,  in  relation  to  hypothecary 
value,  166;  in  relation  to  net  in- 
come,  168. 

Listing  of  bonds,  the,  as  facilitating 
transactions,  162;  in  relation  to  mar- 
ketability, 163;  in  relation  to  negotia- 
bility, 159;  in  relation  to  security, 
158. 

Listing  of  stocks,   170. 

Lists  of  states,  see  State  and  States. 

Little  Rock,  Ark.,  in  default,  686. 

Loan   of   municipal    credit,    640. 

Loans,  demand,  91. 

Local  causes  for  the  increase  in  com- 
modity prices,  1538-1541. 

Local  demand  as  a  price  factor  of  mu- 
nicipals, 696. 

Location  of  railroads  as  affecting  statis- 
tical considerations.  761-763. 

Logarithms  applied  to  equations  of 
present  worth,   1304. 

Long  term   bonds,   338. 

Louisiana,  in  default,  397;  repudiation 
of  state  bonds.   662. 

Louisville,  and  Nashville  First  Collat- 
eral Trust  5s  of  1931,  227. 


Low  rate  bonds,  329. 
Low  yield  bonds,  330. 
Lumber     (see    also    Timber)     business, 
the,  1152  et  seq. 

McGregor,  la.,  in  default,  686. 

Macon  County,  Mo.,  persistent  repudia- 
tion, 501. 

Maine,  history  of  her  early  debt,   384. 

Maintenance   items,   railroads,   795-812. 

Maintenance,  of  railroad  equipment, 
797,  801-803,  811,  812;  of  way  and 
structures,  796,  802,  807-810. 

.Management,  history,  and  earnings  of 
lumber  companies,  1188-1190. 

Management  of  railroads,  756;  of 
steamship  companies  in  relation  to 
the  bonds,  977;  of  street  railway 
companies,  1023,  1026,  1027,  1038; 
of  water  companies,   1092-1096. 

Margin  and  factor  of  safety,  841-849. 

Margin  of  safety  in  equipment  bonds 
(including  diagram),  960-963. 

Market  and  yield,  of  gas  bonds,  1069; 
of  irrigation  bonds,  1240. 

Market  factors  of  state  bonds,  457-460. 

Market,  for  levee  and  drainage  district 
bonds,  1250;  for  municipal  versus 
state  bonds,  406;  for  United  States 
bonds,  360,  361;  for  unlisted  bond 
house  "specialties,"  158;  for  water 
power,  1114  et  seq. 

Market  value  in  the  accountancy  of 
investments,  1378,  1379. 

Marketability,  see  Convertibility  and 
Negotiability,  also  Current  versus 
uncurrent   bonds. 

Marketability,  and  income  of  timber 
bonds,  1191;  and  investment  value 
of  water  power  bonds,  1124;  as  af- 
fected by  size  of  issue,  163;  bonds 
versus  mortgages,  152;  in  relation  to 
listing,  163;  of  insurance  contracts, 
42;  of  loans,  nature  of,  41-45;  of  the 
great  railroad  refunding  issues,  163; 
stocks   versus   bonds,    76-78. 

Maryland,  history  of  her  early  debt, 
385,  386. 

Massachusetts  314s,  158;  net  yield, 
355. 

Massachusetts  Board  of  Gas  and  Elec- 
tric Light  Commissioners,  annual  re- 
ports of,   1053   et  seq. 

Massachusetts,  history  of  her  early 
debt,  384;   state  credit,  419. 

Massachusetts  savings  banks,  average 
dividend  rates,  1280;  methods  of  bond 
accountancy,  1377. 

Material  assets,  of  cities  and  towns. 
518;   of  counties,  469  et  seq. 


INDEX 


543 


(The  references  are  to  section  numbers) 


Mathematics  of  Bond  Values,  Chap. 
XXXIV,  1253  et  seq. 

Maturity  of  loans,  see  Duration. 

Memphis,  Tenn.,  in  default,  686;  re- 
pudiation, 740;  school  bonds  of  1937 
secured  by  mortgage,  576. 

Metropolitan,  cities,  584;  counties,  508; 
districts,  743. 

Michigan,  default  on  state  debt,  388. 

Michigan  savings  bank  law  in  relation 
to  steamship  bonds    (text),  981. 

Mileage  in  railroad  statistics,  764-767. 

Mill  Stocks,  New  England,  marketabil- 
ity of,  170. 

Milwaukee  Gas  Light  and  Power  Co. 
First  4s,  138. 

Minneapolis  and  St.  Louis  First  Con- 
solidated 5s,  118. 

Minneapolis  sinking  fund  investments, 
616. 

Minnesota  repudiation,  395. 

"  Miscellaneous  investments "  in  the 
railroad  balance  sheet,  879. 

Miscellaneous  items  in  the  railway  in- 
come account,  854. 

Mississippi,  default  on  state  debt,  388, 
393,  400,  403,  410,  416. 

Missoula  Park  County,  Mont.,  498. 

Missouri  decision  on  priority  of  equip- 
ment payments,  926. 

Missouri  default  in  interest,  396. 

Missouri,  former  attitude  toward  re- 
pudiation, 685,  686. 

Missouri  Pacific  First  and  Refunding 
5s,  267. 

Missouri  River  as  a  water  supply,  1108. 

Mobile,  Ala.,  Funding  bonds  of  1882, 
576;  in  default,  686. 

Modern  equipment  trust  deed,  928,  929. 

Montana,  indication  of  recent  good 
faith,  421. 

Montreal  Light,  Heat,  and  Power  Co., 
1103;  competition,  1116. 

Mora  County,  N.  M.,  491. 

Mortgage  claim  of  the  municipal  bonds 
of  New  England,  573. 

Mortgage  collateral  trust  bonds,  226. 

Mortgage  debentures,  287. 

Mortgage  guaranty  companies,  the  fees 
of,  137. 

Mortgage  incidence,  table  of  bonds  clas- 
sified under,  183. 

Mortgage  income  bonds,  nature  of,  278. 

Mortgage  priority,  discussed,  260;  in 
railroad  issues,  892-897;  table  of 
bonds  classified  under,   183. 

Mortgage  security,  for  city  and  town 
bonds,  571-581;  for  irrigation  dis- 
trict bonds,  732;  for  tax  district 
bonds,  731. 


Mortgages,  Bonds  Versus,  Chap.  VI, 
112  et  seq.;  denomination  of,  151, 
152;  equity  in  American  real  estate 
mortgages,  116;  freedom  from  care 
of,  147-149;  hypothecary  value  of, 
48,  143,  144;  income,  133-141;  dimin- 
ished by  fees,  136;  marketability, 
142;  security  of  interest,  125-132; 
security  of  principle,  113-120;  tax 
exemption  of,  145,  146. 

Muhlenburg  County,  Ky.,  504. 

Municipal  bond  price  movements  in  re- 
lation to  listed  railroad  bonds,  1406 
and  note. 

Municipal  bonds,  default  on  does  not 
mature  the  principal,  36;  proper,  in 
the  classification  table,  178;  tax  ex- 
empt within  their  states,  704,  705, 
707. 

Municipal  buying  by  the  bond  houses, 
1571. 

Municipal  corporations  proper,  512, 
513;  counties,  real  debt  of,  478,  479; 
debt,  590  et  seq.;  division  of  tax 
secured  bonds  in  the  scheme  of  bond 
classification,  463-466;  loans  in  the 
classification  table,  178;  mortgage 
bonds  in  the  scheme  of  bond  classi- 
fication, 246;  ownership  of  water 
companies,  1093-1096;  real  estate  as 
municipal  assets,  564,  565;  versus 
corporation  mortgage  bonds,  priority 
of  claim,  579-581;  versus  rural  coun- 
ties, 506-507;  water  bonds,  567-570; 
water  bonds  secured  by  realty,  246. 

National  bank  demand  for  United 
States  bonds,   361. 

National  banks,  as  clearing  houses  of 
credit,  1452;  eligibility  of  leasehold 
mortgage  bonds  for,  1151;  The  Gam- 
ble in  "  Governments  "  by,  Appendix, 
1587  et  seq.;  relative  amounts  of  the 
various  classes  of  loans  in  1909,  1601. 

National  debt,  history  of,  357. 

National  Irrigation  Act,  1204-1207. 

Nature,  of  the  security  for  water  power 
bonds,  1105  et  seq.;  of  water  power 
company  contracts  with  consumers, 
1118. 

Nebraska  City,  Neb.,  in  default,  686; 
Precinct,  repudiation,  739,  740. 

Negotiable  bonds  in  the  development  of 
bond  law,  5. 

Negotiability  (see  Marketability)  of 
real  estate  debentures,  1134-1135;  of 
real  estate  mortgage  boi«ds,  1145. 

Net  capitalization  of  railroads,  885. 

Net  corporate  income  of  railroads,  839, 
840,  «50-854. 


544 


INDEX 


(The  references  are  to  section  numbers) 


Net  debt,  as  affected  by  sinking  funds, 
620;  as  defined  by  Massachusetts, 
604 ;  as  related  to  water  bonds,  569 ; 
of  cities  and  towns,  601-612;  uncer- 
tainty of  amount  of,  666. 

Net  dividend  yield:  perpetual  securi- 
ties,  1255. 

Net  earnings  of  railways,  819-821. 

Net  income  (see  also  Income,  Net  yield, 
Net  returns,  etc. ) ,  as  the  basis  of 
investment  worth,   60. 

Net  Interest  Rate,  see  Net  yield,  Net 
income,  etc. 

Net  operating  revenue  of  railroads,  819- 
821. 

Net  returns  (see  Net  yield,  Net  in- 
come, etc.),  nature  of,  1254. 

Net  yield  (see  also  "To  find  the  net 
yield  of  "),  as  the  basis  of  in- 
vestment value,  1374-1376;  as  the 
basis  of  the  bond  value  tables,  1266; 
factors  determining  net  dividend  and 
net  interest  yield,  1267  et  seq. ;  in 
relation  to  bonds  that  must  be  or 
have  been  redeemed  at  a  premium, 
1269,  note,  1310;  in  relation  to  serial 
bonds,  1309;  of  levee  and  drainage 
district  bonds,  1248;  of  real  estate 
debentures,  1133;  of  real  estate  mort- 
gage bonds,  1143;  of  terminable 
securities,  1261  et  seq.;  of  water 
power  bonds,   1120. 

New  England  municipal  bonds,  mort- 
gage claim  of,  573. 

New  Hampshire,  history  of  her  early 
debt,  384. 

New  Jersey,  certification  of  the  valid- 
ity of  school  bonds,  673;  history  of 
her  early  debt,  385;  school  district 
bonds  secured  by  lien,  574. 

New  Orleans,  La.,  in  default,  686. 

New  York  Central  Railroad  equipment 
loan  issued  in  1907,  968;  Refunding 
3y2s,  market  for,  171;  the  rental 
item  of,   834. 

New  York  City,  bonds,  security  of  and 
fluctuation  in,  1403;  debt  limit,  612; 
growth  in  land  values,  1125;  sinking 
fund  investments,  616. 

New  York,  Lake  Erie,  and  Western 
equipments  in  receivership,  938. 

New  York,  New  Haven,  and  Hartford, 
bonds  as  notes  and  debentures,  190; 
relation  of  passenger  to  freight  busi- 
ness, 768. 

New  York  State,  credit,  419;  history 
of  her  earl  debt,  385,  386;  law 
regarding  private  bankers  who  ac- 
cept deposits,    1577. 

Nez  Perces   County,   Idaho,   489. 


Nominal  interest  rate,  1272. 

Nun  cumulative   income  bonds,   320. 

Nun  dividend  paying  gas  companies  in 
Massachusetts,    1053. 

Norfolk  and  Southern  equipments  in 
receivership,  955. 

Norfolk  and  Western  equipments  in  re- 
ceivership,  941. 

North  Carolina,  in  default,  397;  State 
Supreme  Court  decision  in  Pitt 
County  versus  MacDonald,  420. 

North  Dakota  certification  of  the  valid- 
ity of  municipal  issues,  670. 

Northern  Pacific  equipments  in  receiv- 
ership, 943. 

Notes  (short  term),  cause  and  pur- 
pose, 190. 

Ohio  in  financial  difficulties,  390. 
Oklahoma,  certification  of  the  validity 

of  state   and   municipal    issues,   674. 
"  One   industry "   towns   in   relation   to 

municipal  credit,  690. 
Onslow  County,  N.  C,  504. 
Ontario,   Can.,  validation  of  municipal 

issues,   676. 
Operated  mileage   of  railroads,  764-767. 
Operation    of    railroads,    statistics    of, 

775-782. 
Operating   and   holding   companies    for 

gas  concerns,   1068. 
Operating  expenses  of  railroads,  items 

of,  etc.,   794-801. 
Operating  income  of  railroads,  826. 
Operating   ratio,   of   railroads,   818;    of 

water  power  companies,  1122. 
Operating  revenues  of  railroads,  items 

of,  etc.,  789-793. 
Optional  bonds,   342. 
Optional  duration  of  bonds  as  affecting 

price  and  yield,  1369-1372. 
Optional  loans,  88-101. 
Oregon  Short  Line  Refunding  4s,   138. 
Origin  of  equipment  trust  obligations, 

899-907. 
Origin  of  timber  land  bonds,  1158-1161. 
Other  income  of  railroads,  827,  828. 
Output   of    American   bonds    per   year, 

1562. 
Outside    operations    of    railroads,    822, 

823. 
Overcapitalization    of    street    railways, 

1021. 

Paducah  Light  and  Traction  Co.  fran- 
chises,   1029. 

Paper  collateral  security,  table  of  bonds 
classified  under.    183. 

Par  value  of  stocks,  65. 

Participating  bonds,  nature  of,  322. 


INDEX 


545 


(The  references  are  to  section  numbers) 


Partition,     of     counties,     489-495;     of 

states,  494. 
Pass-books     as     representing     demand 
loans,  93. 

Passenger  density,  777. 

Passenger  train  mileage,  781. 

Passenger  trainload,  781. 

Pennsylvania,  history  of  her  early  debt, 
385,  386. 

Pennsylvania  (or  Philadelphia)  plan 
of  issuing  equipment  paper,  914-917. 

Pennsylvania  Railroad  Co.,  Convertible 
3%s  of  1915,  short  terminal  coupon, 
1361;  diversified  ownership  of,  1426; 
primacy  of,  the  reputed  cause  of, 
853;  sinking  funds,  837;  stock  of,  as 
an  investment,  87. 

Penny-wise  street  railway  financing, 
1026,  1027. 

People's  Gas  Light  and  Coke  Co.  Re- 
funding 5s,  market  for,  171. 

Per  capita  studies   in  population,  587. 

Pere  Marquette  equipments  in  receiver- 
ship, 947. 

Perpetual  or  indeterminate  bonds  or 
loans,  102-106,  341;  net  dividend 
yield  of,  1255;   definition,  1369. 

Perpetuity  of  the  interest  rate,  130. 

Personal  property  as  security,  nature 
of,  216;  table  of  bonds  classified 
under,   183. 

Personal  property,  in  the  assessment, 
555,  556;  its  development  in  etymol- 
ogy, 3;   its  nature  and  divisions,   1. 

Philadelphia  and  Reading  equipments 
in  receivership,  942. 

Philadelphia,  Pa.,  high  credit,  689; 
plan  of,  issuing  equipment  paper, 
914-917. 

Physical  characteristics  of  railroads, 
757-782. 

Physical  valuation  for  railroads  un- 
fair, 871,  874. 

Pima  County,  Ariz.,  494. 

Pitt's  English  sinking  fund,  617. 

Pittsburg,  Shawmut,  and  Northern 
equipments  in  receivership,  946. 

Plain  bonds,  nature  of,   189. 

Plant  and  business  of  a  water  company, 
1084-1087,   1091. 

Plant  of  a  lumber  company,  1169-1171. 

Planters'  Bank  bonds  of  Mississippi, 
448. 

Pomeroy,  Ohio,  repudiation,  684. 

Poor    (poor  farm)    districts,   714. 

Population,  as  a  factor  in  national 
development  (with  chart),  1415-1417; 
character  of,  affecting  municipal 
credit,  692;  in  relation  to  railroad 
statistics,  762;   of  cities  and  town*, 


582-589;  estimates  of,  583;  of  states 
in  relation  to  state  credit,  441-443; 
served,  in  relation  to  the  gas  busi- 
ness,  1054-1057. 

Port  of  Portland,  Ore.,  as  a  tax  dis- 
trict, 718. 

Portland  and  Rochester  Terminal  4s, 
259,  note. 

Potential  appreciation,  see  Apprecia- 
tion. 

Power  market  (water  power),  1114  et 
seq. 

Power-plant  construction,   1110-1112. 

Preference  Income  Bonds,  nature  of, 
193,   194. 

Preferred  stocks  in  relation  to  fixity 
of  income,  36. 

Premium,  and  discount  as  affecting 
appreciation,  58;  nature  of,  1270. 

Premium  bonds,  nature  of,  176,  331. 

Premium  redemption  as  a  factor  of  net 
yield,   1269,  note,   1310. 

Present  attitude  of  the  states  toward 
their  debts,  412  et  seq. 

Present-day  irrigation  under  state  law, 
1208,   1209. 

Present  legal  status  of  equipment  obli- 
gations, 923-929. 

Present  trend  of  bond  and  stock  prices, 
1471-1475. 

Present  worth,  of  a  future  amount, 
how  found,  1300  et  seq.;  of  interest 
payments,  or  coupons,  how  found, 
1302;  tables  of,  as  substitutes  for 
formulas  and  bond  tables,   1311. 

Prevalence  of  bond-buying  in  North- 
eastern states,   1564. 

Price  equation,  1493  et  seq. 

Price  factors,  in  municipal  loans,  694; 
in  the  better  railroad  bonds,  898. 

Price  fluctuations,  of  stocks  versus 
bonds,  1435  et  seq.;  of  United  States 
bonds,   362-367. 

Price  of  bonds,  see  "  Cost  of  bonds," 
and  "  To  find  the  price  of  ." 

Priority,  of  claim  in  railroad  bonds, 
891-897;  of  municipal  versus  corpo- 
ration  bonds,   579-581. 

Prior  lien  and  mortgage  security  for 
city  and  town  bonds,  571-581. 

Prior  lien  bonds,  261. 

Priority  of  lien  or  mortgage  (see  Mort- 
gage  priority),  260. 

Private  project  irrigation  bonds,  1215- 
1224. 

Privilege  of  redemption  or  recall 
for  bond  issues.  625-629.  (See  Call- 
able,  Redeemable.    Redemption,  etc.) 

Process  of  bond  issue  as  a  source  of 
illegality  in  municipals,  657. 


r>46 


INDEX 


(The  references  are  to  section  numbers) 


Production,  as  a  factor  of  national  de- 
velopment (with  charts),  1418,  1419, 
1424;  of  lumber  in  the  United  States 
since  1880,  1152. 

Profit-sharing  bonds,  nature  of,  332. 

Promissory  notes,  96. 

Property  investment  of  railroads,  877- 
880. 

Property,  its  nature  and  divisions,  1. 

Property,  personal,  its  development, 
1-3.      (See  also  Personal  property.) 

Property  security,  table  of  bonds  classi- 
fied under,  183. 

Proprietary  interest  of  cities  in  rail- 
roads, 561,  562. 

Proprietorship  and  control  of  railroads, 
750-755. 

Prospect,  of  advance  in  bond  prices, 
1477,  1478;  of  decline  in  bond  prices, 
1479-1487. 

Protective  function  of  the  bond  houses, 
1585,   1586. 

Providence,  R.  I.,  high  credit,  689; 
sinking  fund  investments,  618. 

Province  of  Quebec  municipal  debt 
limitation,   639. 

Provisional   certificates,   301. 

Public  service  corporation  bonds,  see 
Public  utility  bonds. 

Public  Service  Corporation  of  New 
Jersey  stock  trust  certificates,  341. 

Public  utility  and  railroad  commissions 
as  supervisors  of  street  railways, 
1017. 

Public  utility  bonds  in  the  classifica- 
tion table,  178. 

Purchase  money  bonds,  nature  of,  302. 

Purchased   line   bonds,   nature   of,   254. 

Purchasing  function  of  the  bond 
houses,   1571-1574. 

Purchasing,  of  corporation  bonds  by 
the  bond  houses,  1571;  of  municipals 
by  bond  houses,  1571. 

Purchasing  power  of  money  in  rela- 
tion to  fixity  of  income,  37. 

Pure  Income  Return,  39,  40. 

Purpose  of  issue,  as  affecting  the  bonds 
of  tax  districts,  711-713;  as  effect- 
ing legality  of  county  bonds,  487;  as 
affecting  the  legality  of  municipal 
issues,  659;  illegitimate,  640;  legiti- 
mate for  state  debt,  414;  state  bonds, 
452. 

Quality    of    (drinking)    water    supply, 

1075-1081. 
Quantity  theory  of  money,  1488  et  seq. 
Quarterly   compounding  of  funds   as  a 

factor  of  net  yield,  1287. 
Quasi-county  bonds,  482,  483. 


Quasi-municipal  corporations,  512,  513. 
Quasi-municipals    in    the    classification 

table,  178. 
Quasi-state  bonds,  455. 
Quebec      (Province)      municipal      debt 

limitation,  639. 
Quincy,  111.,  in  default,  686. 

Railroad  aid  bonds,  498;  in  Illinois, 
repudiation  of,  659. 

Railroad  bonds,  American,  interest  on, 
35,  note;  average  interest  rate  of,  35, 
note,  138,  note;  average  net  return 
of,  138,  note;  good  convertible  issues 
netting  over  4.40  per  cent.,  138;  Pro- 
prietorship, Management,  and  Plant, 
Chap.  XX,  746  et  seq.;  Earning 
Power  and  the  Income  Account, 
Chap.  XXI,  783  et  seq.;  Valuation 
and  the  Capital  Account,  Chap. 
XXII,  855  et  seq. 

Railroad  capitalization,  American,  114. 

Railroad  dividends  in  business  depres- 
sion, 72. 

Railroad  stocks,  American,  average  re- 
turn from,  75;  dividends  on,  35, 
note. 

Railroading,  general  statistics  showing 
importance   of,   747. 

Railway  trust  bonds,  222. 

Raleigh,  N.  C,  Water  6s,  570. 

Range  of  quality  in  county  loans,  468. 

Range  of  stock  and  bond  fluctuations, 
1467-1470. 

Rapidity  of  commodity  exchange,  1525 
et  seq.,  see  also  Velocity  of  circula- 
tion. 

Rate  of  interest,  significance  of,  329, 
482,  628. 

Rates  for  gas,  in  relation  to  popula- 
tion, 1055;  decline  in,  1059,  1060; 
in  relation  to  profits,  1061-1063. 

Ratio,  of  loans  to  deposits  varies  in- 
versely as  average  price  of  listed 
border  (with  chart),  1451  et  seq.; 
of  railway  funded  debt  to  capitaliza- 
tion, 889,  890;  of  railway  income 
to  capital,  886-888. 

Real  debt,  of  cities  and  towns,  596- 
600;  of  municipal  counties,  478-479; 
of  rural  counties,  480. 

Real  Estate  Bonds,  Chap.  XXIX,  1125 
et  seq.;    nature  of,  248. 

Real  estate  debentures,   1130-1137. 

Real  estate  mortgage  bonds,  1138-1146; 
in  the  scheme  of  bond  classification, 
247 ;  the  substitution  of  collateral 
in,  221. 

Real  net  debt  of  cities  and  towns,  601, 
602. 


INDEX 


547 


(The  references  are  to  section  numbers) 


Real  valuation  of  states  in  relation  to 
assessed  valuation.  436. 

Realty  and  personalty  in  assessed 
valuation,  555,  556. 

Realty  security,  table  of  bonds  classified 
under,   183. 

Recall  privilege  for  bond  issues,  625- 
629. 

Receivers'  certificates,  nature  of,  195, 
316. 

Reclamation  Issues,  Chap.  XXXI,  1192 
et  seq.;  Private  Project  and  Carey 
Act  Bonds,  Chap.  XXXII,  1215  et 
seq.;  Drainage  and  Levee  Bonds, 
Chap.  XXXIII,  1242  et  seq.;  in  the 
classification  table,   178,   182. 

Record,  and  future  of  real  estate  de- 
bentures, 1137;  of  steamboat  bonds 
of  the  Great  Lakes,  982. 

Redeemable  bonds,  342-344;  definition 
and  nature,  1369-1372;  how  to  com- 
pute price  and  net  yield  of,  1369- 
1372;  the  privilege  of  redemption, 
625-629. 

Redemption  bonds,  nature  of,  304. 

Referendum  in  relation  to  municipal 
debt  incurrence,  list  of  states  requir- 
ing, 641. 

Refunding  and  extension  bonds,  nature 
of,  253. 

Refunding  bonds,  county,  486. 

Refunding  first  mortgage  bonds,  nature 
of,  266. 

Refunding  issues,  664;  as  affecting 
legal  net  debt,  605;  the  great  rail- 
road issues  that  are  not  listed,  163, 
note;  marketability  of  the  above, 
163. 

Registered  bonds,  nature  of,  323; 
coupon  bonds,  324. 

Regularity  of  interest  payment,  129. 

Reinforced  obligations,  nature  of,  196; 
in  the  classification  table,  183. 

Rejection  of  municipal  issues  in  1907 
because  of  illegality,  653. 

Relation  (see  also  Ratio),  of  bond 
prices  to  the  condition  of  credit, 
1451-1466;  of  commodity  prices  to 
bond  prices,  1558-1561;  of  gas  out- 
put to  population,  1056;  of  gas  rates 
to  population,  1055;  of  gas  rates  to 
profits,  1061-1063;  of  railroad  funded 
debt  to  capitalization,  888,  890;  of 
railway  income  to  capital,  886-888. 

Relative   position   of   the   various   rail- 
road bond  issues,   892-897. 
Remedies   of  invalidity,   668. 
Renewal  bonds,   305,  664. 
Rental    and    insurance    of    capital    as 
components  of  interest,   103,  104. 


Rentals  in  the  railroad  balance  sheet, 

882-884. 
Rentals  of  leased  roads  in  the  railway 
income  account,  834. 

Rentes,   353. 

Replacement  valuation  for  railroads 
unfair,  870,  872. 

Reports  of  street  railways,  1020. 

Republic  of  Cuba   (External  Debt)   5s, 

102. 
Repudiation  and  default  in  War-time, 
395. 

Repudiation,  does  not  date  back  to 
youth  of  the  Republic,  374;  former 
attitude  of  Missouri  toward,  685;  in 
the  Mississippi  Valley,  686;  of  county 
bonds,  497-505;  of  railroad  aid  bonds 
in  Illinois,  659;  of  state  debts,  377 
et  seq.;  Pomeroy,  Ohio,  684;  ulti- 
mate cause,  400-405. 

Requirements  of  mortgage  and  deed  of 
trust  for  timber  bonds,   1162-1163. 

Reservoir  storage  for  water  power  sup- 
ply, 1109. 

Residuals   from  gas-making,    1050. 

Residuary  estate  bonds,  nature  of,  35, 
231. 

Responsibility  of  power  lessees,  1119. 

"  Retail  "  American  bond  houses,  1567, 
1568. 

Revenue  bonds  or  notes,  nature  of,  306. 

Richmond  and  Danville  equipments  in 
reorganization,   934. 

Richmond  Terminal  Co.'s  reorganiza- 
tion plans  in  regard  to  equipments, 
934. 

Riddleberger  bonds  of  Virginia,  448. 

Rio  Arriba  County,  N.  M.,  495. 

Rio  Grande  Western  First  4s,  138. 

Risk,  distribution  of,  as  affected  by 
security-denomination,  152;  as  ap- 
plied to  state  and  municipal  bond 
security,  456,  note. 

Rockford  and   Interurban,   1017. 

Rockland,  Me.,  Water  5s,  570. 

Rural  versus  municipal  counties,  506- 
507. 

Rural  versus  urban  districts,  741. 

St.  Clair  County,  Mo.,  persistent  re- 
pudiation, 501,  502. 

St.  Joseph,  Mo.,  in  default,  686. 

St.  Louis  and  San  Francisco,  General 
(now  First)  5s,  118;  five-year  \yz% 
of  1908,  a  doubly  indirect  lien,  225. 

St.  Louis,  Mo.,  World's  Fair  bonds,   608. 

St.  Louis,  Iron  Mountain,  and  South- 
ern, General  Consolidated  and  Land 
Grant  5s,  118;  River  and  Gulf  Di- 
vision First  4s,  138. 


54S 


INDEX 


(The  references  are  to  section  numbers) 


Santa  Cruz  County,  Ariz.,  494;  water 
bonds,    077. 

Santa    Fe  County,   N.   M.,  495. 

"  Saturation "  of  a  community  with 
trolley  traflic,   1007-1014. 

Sauerbeck's  tables  of  commodity  prices, 
1535. 

Savannah,  Americus,  and  Montgomery 
equipments   in   receivership,  935. 

Savings  banks,  average  dividend  rates 
in   Massachusetts,   1"280. 

Scale,  of  Carey  Act  irrigation  projects, 
1235;  of  private  irrigation  projects, 
1224. 

Scallop  curve  of  bond  prices,  1459-1466. 

Schedules  for  bonds  bought  at  "  price 
and  interest,"  1393-1395;  for  bonds 
bought  on  basis,  1381;  for  bonds 
maturing  at  other  than  regular  in- 
terest dates,  1396;  for  redeemable 
bonds,  1398,  1399;  for  serial  bonds, 
1397;  of  amortization  and  accumula- 
tion,   1380   et   seq. 

School  bonds,  nature  of,  307. 

School  district  bonds  of  New  Jersey 
secured  by  lien,  574. 

School  tax,  the,  721. 

Science  in  investment  a  factor  of 
safety,    1569. 

Science,  the  bond  business  as  a,   13-15. 

Scope  and  character  of  drainage  and 
levee   reclamation,   1243,   1244. 

Seaboard  Air  Line  equipments  in  re- 
ceivership, 948. 

Second  bond  value  formula,  1312. 

Second  consolidated  mortgage  bonds, 
nature  of,  283. 

.Second  general  mortgage  bonds,  nature 
of,  283. 

Second  mortgage  bonds,  nature  of,  279- 
282. 

Second  refunding  mortgage  bonds,  na- 
ture of,  283. 

Second  repudiation   period,  397   et  seq. 

Secondary  income,  of  cities  and  towns, 
557-570;  of  counties,  476;  of  tax 
districts,  730. 

Secured  notes,  nature  of  property 
pledged,  190. 

Securities  Co.  of  New  York  4  per  cent. 
Consols,  102. 

"  Securities  owned "  in  the  railroad 
balance    sheet,    878. 

Security,  as  affected  by  guaranty, 
bonds  versus  mortgages,  121-124;  for 
gas  bonds,  1066,  1067;  of  leasehold 
mortgage  bonds,  1148-1150;  for  levee 
and  drainage  district  bonds,  1245- 
1247;  for  private  project  irrigation 
bonds,    1216    et    seq.;    for    railroad 


bonds    as    affected    by    priority    of 

claim,    891-897;    for    real    estate    de- 
bentures,   1131-1132;    for   real  estate 

mortgage  bonds,  1139-1142;  for  state 

debts:    Tangible  Assets,  427  et  seq.; 

in   liquidation,    1403,    1436,    1467. 
Security   of   Interest    (see   Stability   of 

income),  34-37;  analysis  of,  127-130; 

bonds  versus  mortgages,    125-132;    in 

mortgages,  assured  by  guaranty,  132. 
Security   of    principal    and    interest   as 

affected  by  speculation,  1400-1403. 
Security    of    principal,     bonds     versus 

mortgages,     113-125;      definition     of, 

30;  stocks  versus  bonds,  64-67. 
Security   of    state   bonds   as   vested   in 

the  issues,  447-450. 
Selling  bonds,  10. 
Selling    function   of    the    bond   houses, 

1580-1584. 
Senior  issues,  263. 
Serial   bonds,   336;    in   relation   to   net 

yield,    1308;    to    find    the    price    of, 

1363-1366;    to   find  the  net  yield  of, 

1367,  1368. 
Serial    payment,    of    debt,    621-624;    of 

equipment  bonds,  953,   954,  960-963; 

diagram  of,  962;  of  state  loans,  448- 

450;   of  steamboat  bonds,  984. 
Sewer   bonds   and   sewer   trunk   bonds, 

nature  of,  308. 
Shawinigan     Water    and     Power     Co., 

1103. 
Shifting  of  collateral,  221. 
Short  term  bonds,   338. 
Short    term    investment,    the    leading 

channels  of,   109. 
Short  term  notes,   cause  and  purpose, 

190. 
Shreveport,  La.,  in  default,  686. 
Significance   of   the   interest   rate,   329, 

482,  628. 
Silver  bonds,  332. 
Silver,    demonetization    of,    in    various 

nations,    1486. 
Simple  obligations,  nature  of,   184;    in 

the  classification  table,   183. 
"  Single  boat  "  bonds,  979  et  seq. 
Sinking    fund    bonds,    nature,    purpose, 

classification  and  description  of,  235- 

244. 
Sinking  fund  demand  for  state  bonds, 

459. 
Sinking    fund    payments    secondary    to 

other  fixed  charges,  railroads,  832. 
Sinking   fund   versus   serial   repayment 

of  state  loans,  448-450. 
Sinking    funds    and    serial    repayment 

for  timber  bonds,  1183-1187. 
Sinking   funds,   as   affecting  net  debt, 


INDEX 


549 


(The  references  are  to  section  numbers) 


613-620;  for  bond  amortization,  in- 
terest rates  of,  1276-1282,  1284-1286, 
1305-1309;  for  railway  bonds,  decline 
of,  835;  for  railroad  bonds,  history 
and  advisability  of,  237;  for  water 
company  bonds,  1098,  1099;  in  rela- 
tion to  net  debt,  620;  misappropria- 
tion of,  for  special  assessment  bonds, 
722;  of  Pennsylvania  may  be  di- 
verted, 448;  suspension  of  payments 
to,  England,  United  States,  Indiana, 
Pennsylvania,  619;  versus  serial  re- 
payment, 621-624. 

Sioux  City,  la.,  School  District  bonds, 
744. 

Size  and  population  served,  importance 
of,  in  the  gas  business,  1054-1057. 

Soetbeer's  tables  of  gold  production, 
1503. 

Source  of  municipal  debt  limitations, 
630. 

South  Carolina   in  default,   397. 

Southern  Indiana  equipments  in  re- 
ceivership, 957. 

Southern  Railway  common   stock,   158. 

Spartanburg  County,  S.  C,  498. 

Special  assessment  bonds,  483,  722- 
726;  in  relation  to  the  power  of  gen- 
eral taxation,  532;  secured  by  lien 
in  some  states,  575. 

Special  bond  taxes  (see  Specific  bond 
taxes),  534-540. 

Specific  municipal  bond  taxes,  list  of 
states  requiring,  etc.,  534-540. 

Special  tax  levy  for  municipals, 
658. 

Speculation,  as  an  aid  to  convertibility, 
44;  distinguished  from  gambling,  21; 
distinguished  from  investment,  27- 
29;  nature  of,  20-26;  necessary  to 
security  of  investment,   1400-1403. 

Springfield,  Mass.,  high  credit,  689. 

Springfield,  Mass.,  Gas  Light  Co.,  1064. 

Springfield,  Ohio,  School  District  bonds, 
744. 

Stability  of  equities  in  bonds  versus 
mortgages,    117. 

Stability  of  Income,  34-37;  stocks 
versus  bonds,   68-73. 

Stamped  bonds,  nature  of,  200,  201. 

Standard  Oil  stock,  158. 

State  Bonds,  exempt  from  tax,  80;  The 
History  of  State  Debt,  Chap.  XIII, 
370  et  seq.;  The  Elements  of  Secur- 
ity,  Chap.   XIV,   405  et  seq. 
State   census,   list  of   states  having  a, 

582. 
State   certification   of   the  validity   for 

municipal  bonds,  670-676. 
State  debts,  present  amounts  and  na- 


ture   of,    422-426;    present    attitude 
toward,  412  et  seq. 
State  laws  regarding  taxation  of  stocks 

and  bonds,  80. 
States,  list  of,  in  which  mortgages 
are  tax  exempt,  146;  in  which  muni- 
cipals are  tax  exempt,  704,  705,  707; 
limiting  municipal  debt  incurrence, 
and  the  degree  of  limitation,  677; 
requiring  the  referendum  in  connec- 
tion with  municipal  debt  incurrence, 
641;  with  no  bonds  outstanding, 
423;  with  no  debts  outstanding  that 
they  recognize,  425 ;  with  no  "  for- 
eign "  debt,  424 ;  without  general 
debt  limitations,  629. 

Statistical  difficulties  of  studies  in 
bond  prices,   1404-1410. 

Statutory  debt  restrictions  to  state 
debt,  417. 

Steam  power  versus  water  power 
plants,    1103. 

Steamship  Bonds,  Chap.  XXIV,  969  et 
seq.;  of  the  Great  Lakes,  980. 

Stevens   County,  Wash.,   498. 

Stock  interest  certificates,  230. 

Stock  of  car  trust  associations,  910-912. 

Stock  prices  charted,  1429,  1430. 

Stock  trust  certificates,   230. 

Stocks,  the  history  of,  170;  the  nature 
of  as  affecting  security  of  principal, 
64;  versus  Bonds,  Chap.  IV,  63  et 
seq. ;    watering  of,   65. 

Storage  reservoir  for  water  power  sup- 
ply, 1109. 

"Straight"  bonds,  335. 

Strategic  position  in  railroading,  763. 

Street  Railway  Bonds,  Chap.  XXV,  991 
et  seq.;  legal  for  Massachusetts  sav- 
ings banks,  1018. 

Subjects  of  bond  price  study,  1411. 

Subsidy  bonds,  nature  of,  290. 

Substitution  of  collateral,  221. 

Suit  against  Georgia,  373. 

Suit  of  South  Dakota  against  North 
Carolina,  375,  note. 

Suits  against  states, — states  permitting 
themselves  to  be  sued  by  private  cit- 
izens, 375. 

Supervision  and  certification  of  muni- 
cipal issues  by  trust  companies,  669. 

Supplemental  assessments  for  special 
assessment  bonds,  723. 

Surplus  of  railroads,  839,  840,  850-854. 

Tables  of  four  listed  bonds  used  in  the 
charts,  1477;  of  present  worth  as 
substitutes  for  formulas  and  bond 
tables,  1311;  of  ten  listed  bonds  used 
in  the  charts,  1470;  showing  the  rela- 


550 


INDEX 


(The  references  are  to  section  numbers) 


tive  costs  of  sinking  fund  and  serial 

repayment  of  debts,  024. 
Taooma    Cas    Light    Co.    Refunding   5a 

of  1926,  313. 
Tangible  assets  of  states,  427  et  seq. 
Tax  arrearage  bonds,  306,  310. 
Tax  duplicate,  the,  54 ii. 
Tax-exempt  property,  in  college  towns, 

559;    in    New    York    City,  558,    and 

note. 
Tax    exemption,    as    a   price    factor   of 

municipals,  699;   bonds  versus  mort- 

gages,    145,    140;    bonds   in    New    York 

State,    new   law   regarding,  50,  note; 

in  relation  to  investments,  49,  50;  of 

municipals    of    certain    states,    704, 

705,    707;    of    territorial    municipals, 

legal    opinion    of    Chicago    firm    con- 
cerning, 700;  stocks  versus  bonds,  80. 
Tax  district,  see  also  District. 
Tax    (taxing  or  taxed)    district  bonds, 

711   et  seq. 
Tax    limitation,    city   and   town    loans, 

541-545;     of    counties,    470-471;     of 

states,  431. 
Tax   power,   of   cities   and   towns,    532- 

540;   of  counties,  470-471;   of  states, 

428. 
Tax  rate,  of  cities  and  towns,  519,  532; 

of  counties,  472-474;  of  states,  430. 
Tax  receivables,  nature  of,  328. 
Tax  relief  bonds,  nature  of,  306,  311. 
Taxable  wealth,  see  Assessed  valuation. 
Taxability  of  territorial  municipals  as 

bank  assets,  702. 
Taxation  of  bonds  in  New  York  State, 

new  law  regarding,  50,  note. 
Taxation,  implied  power  of,  for  special 

assessment    bonds,    723;    to    support 

municipal   loans.   539-540. 
Taxes  accrued,  of  railroads,  825. 
Temporary    bonds    or    certificates,    313, 

316. 
Temporary  debt,  as  affecting  legal  net 

debt,  605,   606;   of  cities  and  towns, 

591,  592. 
Temporary  receipts,  nature  of,  312. 
Tennessee,  encouragement  of  municipal 

repudiation,  418;   in  default,  397. 
Terminable  bonds,  definition,  1369;  net 

yield  of,  1261  et  seq. ;  nature  of,  259. 
Terminal  Railroad  of  St.  Louis  4s,  259. 
Territorial  municipals,  debt  limitation, 

638;   legal  opinion  of  a  Chicago  firm 

as    to    the    tax-exemption    of,    700; 

taxable  as  bank  assets,  702. 
Territory    served    in    relation    to    street 

railway  earnings,  1036-1038. 
Texas  certification   and  registration  of 

municipal  issues,  671. 


Text-books   on   bonds,   7. 

Third  mortgage  bonds,  nature  of,  279- 
282. 

Timber  and  timber  values,  1172-1178. 

Timber  Bonds,  Chap.  XXX,  1152  et 
seq. 

Timber  lands,  1164-1168. 

Time  loans,   107-111. 

Title  "Street  Railway  Bonds,"  991-993. 

To  find  the  net  yield  at  a  tabulated 
price,  1332;  the  price  at  a  tabulated 
net  yield,  1333;  the  net  yield  at  an 
untabulated  price,  1334;  the  net  yield 
at  a  flat  price,  1341,  1342;  the  price 
at  an  untabulated  net  yield,  1343- 
1345;  the  net  yield  at  an  untabulated 
coupon  rate,  1346;  the  price  at  an 
untabulated  coupon  rate,  1347-1349; 
the  net  yield  at  an  untabulated  du- 
ration, 1350-1353;  the  price  at  an 
untabulated  duration,  1354;  the  net 
yield  at  an  untabulated  interest  in- 
terval, 1355;  the  price  of  a  bond  at 
an  untabulated  interest  interval, 
1356;  the  price  of  bonds  issued  or 
maturing  at  other  than  the  regular 
interest  dates,  1357-1361;  the  price 
of  a  serial  issue,  1363-1366;  the  net 
yield  of  a  serial  issue,  1367,  1368. 

Toledo,  St.  Louis,  and  Kansas  City 
equipments  in  receivership,  936. 

Topeka,  Kas.,  in  default,  686;  Water 
Works  Purchase  4s,  570. 

Topeka   Water  Co.   5s,   570. 

Torrance  County,  N.  M.,  495. 

Total  net  revenue  of  railroads,   824. 

Township  bonds  of  Cass  County,  Ind., 
480. 

Trade  cycle,  the,   1442  et  seq. 

Traffic,  character  of,  in  railroad  analy- 
sis, 768-770. 

Traffic  density,  777,  77S. 

Traffic,  transportation  and  general  ex- 
penses of  railroads,  813-817. 

Trainload,  the,  779,  781,  782. 

Transportation  bonds,  as  a  security 
(dass,  180;  in  the  classification  table, 
178. 

Transportation  expenses  of  railroads, 
815-817. 

Transportation  ratio,  the  railway, 
817. 

Trolley  bonds,  see  Street  railway  bonds. 

'Trust  certificates,  230. 

Trust  company  supervision  and  certifi- 
cation of  municipal   issues,   669. 

Trust  deed  for  modern  equipment  bond 
issues,  928,  929. 

Trust  fund  demand  for  state  bonds, 
459. 


INDEX 


551 


(The  references  are  to  section  numbers) 


Twenty-year  page  of  the  bond  tables, 

sample,  1322. 
Two  kinds  of  Real  estate   bonds,  the, 

1126-1129. 

Unconditional  interest,  bonds  of,  as  a 
class,  319. 

Uncovered  paper,  amount  in  the  world 
in  1907,  1543. 

Underlying  bonds  discussed,  262  et  seq. 

Unfunded  debt  as  affecting  legal  net 
debt,  605,  606. 

Unifying  mortgage  bonds,  nature  of, 
277. 

Union  Electric  Light  and  Power  Co. 
(St.  Louis)    First  5s,   138. 

Union  Pacific  equipments  in  receiver- 
ship, 939. 

United  Railways  of  St.  Louis  fran- 
chises, 1030. 

United  States  Bonds,  Chap.  XII,  353 
et  seq.;  market  for,  171. 

United  States  Steel  corporation,  diver- 
sified ownership  of,  1426;  First  Col- 
lateral Trust  5s,  296. 

Unlisted  bonds,  see  also  Listed  bonds, 
Listing,  etc. 

Unlisted  stocks  versus  bonds,  their  mar- 
ketability, 77. 

Unreliability  of  some  listed  quotations, 
173,  174. 

Unsecured  obligations,  weakness  of  the 
term,  184. 

Urban  street  railways,  995. 

Urban  versus  rural  municipalities,  540. 

Use  of  the  Bond  Tables,  Chap.  XXXV, 
1322  et  seq. 

Validation  of  municipal  issues  by  courts 
and   legislatures,    677. 

Validity,  illegally  issued  bonds  not 
necessarily  invalid,  488;  of  district 
bonds,  734;  of  county  bonds,  485  et 
seq. ;  of  municipal  obligations,  647- 
681;  state  certification  of,  670-676; 
of  state  bonds,  451-455. 

Valuation  of  railways,  Chap.  XXI,  855 
et  seq. 

Vanderlip,  on  gold  production  as  a 
menace,  1551. 

Variations  in  form  or  plan  of  equip- 
ment obligations,  964. 

Variety  of  kinds  of  street  railway 
bonds,  994. 

Velocity  of  circulation,  1498  et  seq.; 
1521,  1522. 

Vermont,  history  of  her  early  debt,  384. 

Virginia  in  default,  397. 

Wabash,  Pittsburg  Terminal  Second  4s, 
158. 


Wall  Street  Journal  on  the  menace  of 

high  prices,  1552. 
Warrants,  state,  446. 
War-time  repudiation  and  default,  395. 
Washington  Terminal  Co.  3y2s  and  4s, 

259. 
Water  bonds   in   relation  to  legal  net 

debt,  603-604. 
Water  Company  Bonds,  Chap.  XXVII, 

1070    et    seq.;    in    foreclosure,    1100, 

1101. 
Water  districts,   715,  717. 
Water    Power    Company   Bonds,    Chap. 

XXVIII,  1102  et  seq. 
Water     power     versus     steam     power 

plants,    1104. 
Water    supply,    for    private    irrigation 

projects,    1217,    1218;    in    Carey   Act 

irrigation   projects,    1229. 
Water  title  and  water  rights   for  pri- 
vate irrigation  projects,   1219,   1220; 

in     Carey    Act    irrigation    projects, 

1230,   1231. 
Watered  land  in  Carey  Act  irrigation 

projects,   1232;   of  private  irrigation 

projects,  1221,   1222. 
Waterworks  as  municipal  assets,  566- 

569. 
Waterworks  bonds,  567-570. 
Wealth   per   capita,   in   relation   to  na- 
tional    development     (with     chart), 

1424,   1427. 
Webster's    letter    to    Baring    Bros,    on 

state  credit,  410. 
West  Shore  Railroad  First  4s,  106. 
West    Virginia    adjudged    liable    for    a 

share  of  the  debt  of  the  old  State  of 

Virginia,  384,  note;  Certificates,  494; 

in  default,  397. 
Western  interurban  development:  com- 
petitive, 1000-1006. 
Western    Union    Telegraph    Co.    Fund- 
ing and   Real   Estate   4%s   of   1950, 

247. 
Wharf  bonds,  nature  of,  258. 
Wheeling   and    Lake   Erie,    equipments 

in  receivership,  952;  First  5s,  118. 
White  and  Kemble's  Atlas  and  Digest 

of  Railroad  Mortgages,  892,  note. 
Wilkes  County,  N.  C,  504. 
Wilson  on  the  tariff  as  a  cause  for  high 

commodity  prices,  1540. 
Wisconsin's   excellent   financial   record, 

392. 
Worcester,  Mass.,  high  credit,  689. 
Wright  Act,  the,   1214. 

Yapavai  County,  Ariz.,  498. 
Yield   (see  Net  yield,  Income,  etc.)  ;  of 
equipment  obligations,  965-968. 


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